Why the active case for emerging markets is getting stronger

Avoiding index-based approach to developing markets exposure can bolster portfolio

Why the active case for emerging markets is getting stronger

Moving from the carried-over momentum of the passive-investing trend over the past several years, investors are still strongly inclined to get their emerging markets allocation from ETFs and other index-based vehicles. But giving up the convenience of working with market cap-weighted indexes in favour of active approaches could lead to some attractive opportunities.

With emerging-markets index funds, investors could make broad macro bets with a tilt toward specific countries, sectors, and large-cap names including many state-owned companies. But as noted by Institutional Investor, those strategies overlook the largely under-researched group of fast-growing corporates.

Looking at the MSCI EM Index, its five biggest holdings are all tech-oriented companies that represent nearly a fifth of its total assets. The index also has a large bias toward China, South Korea, and Taiwan, which could be a concern for those with an eye on geopolitics.

“Many people are naturally worried about China because of things that have happened, which are legitimate fears — whether it’s the geopolitical risk with Trump and now with the new president, or in terms of the greater antitrust enforcement,” Larry Kochard, chief investment officer at Makena Capital, told Institutional Investor. “It overshadows what we still think is the fact that there is a huge number of companies that have enormous markets ahead of them.”

ESG investing could also uncover a rich vein of promising prospects, particularly those that are open to changing for the better. In the case of Stewart Investors, it pursues ESG goals and investments by considering family-owned businesses, which are more inclined to making long-haul changes because of their multigenerational outlooks and the strong equity they attach to their names.

“Over thirty years we’ve built up a knowledge of local businesses and families and their reputations,” said Jack Nelson, a portfolio manager on the sustainable funds group at the firm. “If you’re going to own a stock for 6, 12, 18 years, you better be sure that the people you are investing alongside aren’t the kinds of people that are going to disadvantage minority shareholders.”

Another point in EM businesses’ favour is the fact that local regulations surrounding ESG are generally not as far along as those in developed markets. As explained by Teresa Barger, co-founder of EM manager Cartica, a good investment manager can judiciously engage and help its small portfolio companies adopt best practices and set themselves apart from their rivals for capital.

“This can lower their cost of capital and give them a competitive edge,” Barger told Institutional Investor.


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