According to FE data, the MSCI Emerging Markets Value index returned 7.32% over the 12 months to 31 May 2018 whereas the MSCI Emerging Markets Growth index was up almost double that, at 14.5% (see chart below).
Additionally, there is a discrepancy between the returns of the two main EM indices many funds use as a benchmark: the MSCI Emerging Market index and the FTSE Emerging index.
Over the 12-month period mentioned above, the FTSE index has lagged the MSCI index with a return of 9.24% versus the MSCI EM index’s 11.02%.
Buoyed by tech
According to Liontrust head of multi-asset John Husselbee, the FTSE index has lagged because it has less of the booming technology companies among its constituents compared with the MSCI index. The past 12 months has been a growth market in emerging markets with the ‘Bat’ stocks – Baidu, Alibaba and Tencent – among the best performers.
The FTSE index has 16.03% in technology whereas the MSCI index has 28.65% in technology.
Another boon for the MSCI index has been its exposure to South Korea. The MSCI index has 15.36% in South Korea and the FTSE index has no exposure. “If you are going to be investing Korea you are basically investing in technology,” says Husselbee.
As a result, funds tracking the FTSE index are likely to have returned less over the past 12 months. Meanwhile, an MSCI index-tracking fund would generally have ranked in the top quartile, compared with a FTSE index-tracking fund typically in the third quartile.
Taking two funds as an example, the MSCI index-tracking Fidelity Index Emerging Markets fund has returned 3.3% over the past year, while the Legal & General Global Emerging Markets Index fund, which tracks the FTSE All-World Emerging Index, returned 2.5%, according to FE data (see chart below).
Two camps
Husselbee says: “Within that sector today there are a number of funds broken into two camps: those tracking the MSCI and those tracking the FTSE. Over the last 12 months that has made quite a difference in terms of which funds you are tracking.
“There has been a clear tilt towards growth and to capture that you have had to be with an MSCI tracker not a FTSE tracker.”
He added that there is also the fact that most active managers in the sector tend to have a value rather than growth bias, which would have hurt their returns and made passive attractive to fund selectors.
But he notes that over a seven-year period (the length of time these trackers have been running) both MSCI and FTSE trackers rank in the middle of the IA Emerging Market Sector, which suggests active management in EMs is effective over longer time periods.
He says: “Over a seven-year period perhaps active management has been worthwhile.”
Passive is active
This choice between which index to track therefore makes it an active decision, despite the fact it is using passive funds, says Husselbee.
“Going passive is an active decision,” he says.
This could explain why fund selectors our sister publication Portfolio Adviser spoke with have seen fit to opt for a passive approach to emerging markets over the past 12 months.
Mike Coop, head of multi-asset portfolio management at Morningstar Investment Management, uses both active and passive depending on the portfolio and client.
Better information
Coop says 20 years ago there was a stronger case for active management in EMs, but that has changed as disclosure standards and access to information is much better than it used to be.
“There has been an emancipation of retail investors who can access things through ETFs that just wasn’t possible 20 years ago. Now people can invest actively and passively and so it is inevitable there will be a mix of that.”
However, Coop says active fees have not come down to the same extent in EMs as they have for developed market equities so when comparing active and passive, it pays to be mindful of the additional cost.
“This is not always obvious so it comes down to the funds available and whether you believe the manager has sufficient skill and the risk. It should not be assumed that if you want a great return you go active,” he adds.
Not a clear-cut case for active
For David Marchant, chief investment officer at Canada Life Investments, his policy on deciding whether to go active or passive is to first decide whether he and his team have the ability to do it in-house. If not then he will look to partner firms that are part of the Great-West Life stable, which Canada Life is part of, and/or external providers.
When outsourcing, a passive approach is usually the default option. With emerging markets Marchant prefers passive because it is lower cost and the case for active is not strong enough. He uses a Blackrock tracker for access to EMs but says that remains under review and he is open to switching.
In Canada Life’s multi-asset range, exposure to emerging markets is 14% of the LF Canlife Portfolio Seven, 8% of Portfolio Six and 5% of Portfolio Five.
He says: “We have to bear in mind: do active people do better or worse in this market? Our experience of this is it’s not clear cut and we are happy to have passives.
“We used an active manager a few years ago, but dropped them because of costs and performance.”
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