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Jay Kumar
May 20 2019

The need for active managers for Emerging Market equity

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The need for active managers for Emerging Market equity
<p><span style="font-family:Arial,Helvetica,sans-serif"><u><span style="color:#e74c3c"><strong>Key insights</strong></span></u></span></p> <ul> <li><span style="font-family:Arial,Helvetica,sans-serif">Global emerging markets have provided very strong returns for long term investors.</span></li> <li><span style="font-family:Arial,Helvetica,sans-serif">However, investors must be prepared to accept higher volatility over shorter periods of 3 years and less.</span></li> <li><span style="font-family:Arial,Helvetica,sans-serif">Significant performance dispersions across regions, countries, sectors and styles factors provide substantial opportunities for active managers.</span></li> <li><span style="font-family:Arial,Helvetica,sans-serif">Smart-beta or factor strategies have delivered mixed results &ndash; while Minimum Volatility and Sustainability factor indices have delivered strong results, traditional factor indices such as Value and Growth have disappointed.&nbsp;</span></li> <li><span style="font-family:Arial,Helvetica,sans-serif">The level volatility and dispersion of risk factor across major countries continue to rise, reflecting greater geopolitical risks and country level policy risks.</span></li> </ul> <p><span style="color:null"><span style="font-family:Arial,Helvetica,sans-serif"><strong>Emerging Market equities can be a source of strong returns over the long term.</strong></span></span></p> <p><span style="font-family:Arial,Helvetica,sans-serif">Over the long term, emerging markets (EM) can be an attractive source of uncorrelated returns for investors. The total return chart (Exhibit 1) since 2005 shows EM equity has outperformed DM, World and Frontier markets by a notable margin. Investments in EM (unhedged) grew at an annual compound rate of 8.44% in comparison to a Developed Market (DM) average of 7.31% per annum, since 2005.</span></p> <p class="image-align-center"><img alt="" height="300" src="https://tat.capital/docs/uploads/2019/05/EmergingEquityMarkets.jpg" width="750" /></p> <p style="text-align:center"><span style="font-size:9px"><em><u><strong>Exhibit 1: Investors with long term investment horizon can gain from investing</strong>&nbsp;</u></em></span></p> <p style="text-align:center">&nbsp;</p> <p><span style="color:#000000"><strong>Cyclical Performance of two major countries in EM-India and China</strong></span></p> <p>Emerging markets include two of the world&#39;s most populous countries &ndash; India and China. These two countries represent almost 40% of MSCI EM index weights for instance. China&#39;s weight in the index has gone from 17% in 2014 to 30% today, which is quite substantial. It is expected to rise further in the coming months according to MSCI.</p> <p class="image-align-center"><img alt="" height="300" src="https://tat.capital/docs/uploads/2019/05/Ind-China EM.jpg" width="750" /></p> <p style="text-align:center"><span style="color:#000000"><span style="font-size:9px"><strong><em>Exhibit 2: Chinese Equity Market is more Volatile than Indian Equities (in AUD)</em></strong></span></span></p> <p><span style="color:#000000"><strong>Sector dispersion has been very high over the past year; IT and Staples lead over the longer term.</strong></span></p> <p>&nbsp;Analysis of sectoral compositions showed interesting patterns of high dispersion but also a high level of persistence by the IT sector over the longer term.IT sector has delivered very consistent results over the past 5, 7 and 10 year periods with returns in higher teens over these periods. That said, the last 12 months have been very volatile with the sector delivering -3.7% returns.</p> <p class="image-align-center"><img alt="" height="300" src="https://tat.capital/docs/uploads/2019/05/EMSector performance.jpg" width="750" /></p> <p style="text-align:center"><span style="font-size:9px"><strong><em>Exhibit 3: Sector performance shows IT stocks are best performing over the long term</em></strong></span></p> <p><br /> <span style="color:null"><strong>The Importance of Style and Risk Factors in EM</strong></span></p> <p>Apart from the country, regional and sectoral risks, style factors can also explain part of the dispersion in returns for EM equity market constituents. The analysis has shown that style factors that have had a notable impact on EM stock returns over the past 1, 3 and 10 years. Overall, the data-set showed that Growth, Value and Quality factors have had the most influence on EM equity returns.</p> <p><span style="color:null"><strong>Performance of Smart-beta Indices.</strong></span></p> <p>There are various indices that are available to investors to replicate or invest in linked ETFs to capture factor-specific returns. These performance patterns are very interesting as they show that traditional smart-beta factor indices may/or losing their performance edge and no longer enjoy the following as they did several years ago.</p> <p><span style="color:null"><strong>Geopolitical risks and Policy uncertainty have underpinned rising volatility in EM</strong></span></p> <p>The dataset demonstrated that over the period of March 2004 to March 2019, all five BRICS countries have exhibited higher rolling volatility than the overall Emerging Markets. &nbsp;Investors should be cognizant of the underlying shifts in risk patterns and where possible allocate their money via active managers that have skill in navigating through uncertain times.</p> <p><span style="color:#e74c3c"><strong>Conclusion:</strong></span></p> <p>Despite the rising dispersion and volatility in Emerging market equities, long term investors can harvest superior returns from this asset class. Notable dispersions across regions, countries, sectors and styles mean active managers are better placed to take advantage of stock, country and sector level anomalies and position the portfolio for strong outperformance in the coming years. Rising geopolitical and individual country policy and political risks mean volatility for the asset class will continue to rise. We believe active managers are best placed to navigate through uncertain times and take advantage of opportunities for investors.</p> <p><u><strong>Source</strong></u>:&nbsp;<a href="https://www.livewiremarkets.com/wires/why-investors-should-use-active-managers-for-emerging-market-equity" target="_blank">LiveWireMarkets</a></p>

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