Source: Hewitt EnnissKnupp
The spread in regional returns within the equity market during 2013 was large, and few more extreme than the spread of the strongly performing U.S. market (33.6%) as compared to the markedly weaker emerging market (-2.6%). There were a number of issues at play throughout the year causing the weak absolute result within emerging markets, including, but not limited to:
- The continued slowdown in China as the move from investment led to domestically led growth;
- Cracks appearing in China’s shadow banking system which resulted in mystery bailouts; and
- The worsening macroeconomic conditions in Brazil, India, Turkey, South Africa and Indonesia that led to the creation of the ‘Fragile Five’ moniker.
The start of 2014 saw further pressure on emerging markets as political uncertainty in Russia and Ukraine, and the eventual Russian annexation of Crimea, sent Russian markets, in particular, reeling. However, emerging market bulls are keen to point out the following factors that may suggest a more constructive view of the opportunities in emerging market equities:
- Attractive valuations relative to history;
- Superior economic growth in emerging markets relative to developed markets (albeit a lower differential than in the past); and
- The extreme negative sentiment towards emerging markets as evidenced by the flows out of emerging markets (Retail and ETF related in particular), and the negative positioning surveys of investors that are construed by contrarians as a bullish signal.
Hewitt EnnisKnupp’s asset allocation team believes emerging markets to be modestly attractive. In particular, HEK believes valuations in emerging markets to be compelling relative to developed markets from a medium term viewpoint (available upon request). Granted, we note the three-year time horizon for HEK’s medium term views relative to manager turnover which is more consistent with a two-year time horizon.
As part of our ongoing research, we pay careful attention to changes in positioning of portfolios that are discussed in our regular reviews with investment managers. Additionally, we review data that is available through our proprietary systems. While initially an exercise for our BUY-rated managers, we undertook an analysis of the changing emerging market positioning of the managers in the entire universe, seeking any notable trends or changes within that data set.
There appears very little consensus amongst the Global ex-U.S. and Global equity managers on whether lagging emerging market performance represented a buying opportunity. On average, the relative weight to emerging markets fell during the year.
However, further analysis below identified groups of managers that did use this opportunity to buy into weakness. Managers who identified themselves as either core or growth allowed their holdings to fall during the year, either by not purchasing more stock or outright selling as shown below. Using managers’ average positions and market returns, this implies that Core- or Growth- oriented global managers essentially maintained their emerging market weight (a reduction of -0.04% on average) and Global ex-U.S. managers sold marginally (a reduction of -0.4% on average). There was very little differentiation between the behavior of core and growth managers.
However, both Global and Global ex-U.S. value-oriented managers maintained their weightings to emerging markets, on average. Given the marked underperformance of emerging markets relative to developed markets, this suggests additional purchases of emerging market stock throughout the year. Using managers’ average positions and market returns, this implies value-oriented Global managers increased their emerging market weight (an increase of 1.2% on average) and Global ex-U.S. managers also increased their emerging market weight (an increase of 1.6% on average). The cliché of value managers buying stocks that are out of favor and purchasing them from growth managers held true over 2013. The same results held true for our BUY-rated managers.
Despite the marked underperformance of emerging markets, it appears that managers remain divided on whether this presents a potential buying opportunity. However, Value-oriented Global and Global ex- U.S. managers have used this opportunity to dip their toes in the water by purchasing emerging market stocks. This appears consistent with our interactions with the manager community in general. Managers have generally identified this weakness, are spending increasing amounts of time in emerging markets seeking new ideas, but also point out dispersion in opportunities within emerging markets.
A Note on the Methodology:
We utilized data from the eVestment Alliance database of some 428 Global ex-U.S. equity and 513 Global equity managers to attempt to answer this question. We took the managers’ average positionings as of December 2012 and December 2013 and compared this against the relevant benchmarks. We also looked at the relative positioning quarterly between December 2012 and December 2013, and as expected, the results were very similar. We calculated the amount that managers actively traded in emerging markets by reviewing the beginning and ending market values relative to benchmark. We used the manager-specified style as listed in eVestment Alliance. There were only a handful of managers that did not provide regional data.
Adrian Kurniadjaja is a senior consultant in Hewitt EnnisKnupp’s Equity Manager Research group.
Disclaimer: The information contained above is intended for general information purposes only and should not be construed as legal or investment advice. Please consult with your independent professional for any such advice.