Why EM managers have underperformed this year
Investors in emerging market stocks will be feeling particularly disgruntled this year; not only are these markets down nearly 10% in price, most active funds invested in the asset class have fared even worse.
Typically, two-thirds of equity managers specialising in emerging markets beat their benchmark, according to Copley Fund Research, but so far in 2018 some 60% of them have underperformed.
The average underperformance of funds tracked by Copley is about one percentage point. On its website, the firm says it tracks more than 180 global emerging market equity strategies.
The main reasons for the lag in manager returns are the crises in Argentina and Turkey, Steven Holden, founder of New Zealand-based Copley, said at a conference last week.
The Argentine peso currency has more than halved in value against the US dollar this year, and country has agreed a $57 billion bailout package from the IMF. Turkey’s lira, meanwhile, has shed almost 40% this year, amid pressure from US sanctions and the continued defiant rhetoric of President Recep Tayyip Erdogan.
The two countries only account for small positions in most emerging market funds, but the size of the market moves has been so large that it has contributed to portfolio underperformance, noted Copley. He was addressing the FT Investment Management Forum in London on September 25.
Argentina’s Merval stock index plunged 29% from 35,126 on January 28 dropped to 25,033 on August 28, but has since recovered to 32,201 as of October 3. The Borsa Istanbul 100 index fell 28% from 120,845 on January 29 to 87,143 on August 16 – but it has not rebounded to the same degree, closing at 97,187 on October 3.
An additional problem for emerging market managers is that they tend to underweight Taiwan because it is a “semi-developed market”, Copley said. This has hurt performance because the country’s stocks have held up very well amid the wider emerging market woes, with almost flat returns for 2018 as of this week.
Still, it may be that investors can expect a bounce in the coming months if they have been prepared to brave Argentina and Turkey again.
“The reason active EM managers tend to outperform … [is that] this sort of thing gives managers the opportunity to buy into stocks at depressed levels,” Copley said.
He noted that Russian shares dropped heavily in 2014, when Russia invaded Crimea, but have risen 36% since then.
“[Emerging market managers] may suffer some underperformance in the short term, but long term these trends tend to pay off, and I expect that to happen with Turkey and Argentina as well.”
Copley added that a 10% drop in emerging market equities is not unusual. “The high-low percentage [from peak to trough] for the past three years has been about 30% to 35%, so we’re well within that.”
But “it feels worse” than it is because of the high-profile events in Argentina and Turkey, and the US-China trade tensions, he said.
TIME TO GET BACK IN?
Certainly, some investors see emerging market stock valuations as attractive now. One is Carmel Peters, head of global emerging markets at Universities Superannuation Scheme, a UK pension fund with £60 billion ($78 billion) under management.
Emerging market equities have probably seen most of the capital outflows they are going to see in this downturn, as around $30 billion has been withdrawn since April, she said, speaking on the same panel as Copley.
Yet Peters remains cautious. Emerging markets are unlikely to rebound strongly by the end of 2018, she argued. “There are issues that are not going away – particularly the trade war.”
Rising US interest rates, combined with the growing American protectionism, is also sucking capital back to US markets.
Even so, Markus Stadlmann, chief investment officer at London-based Lloyds Bank, sees selective opportunities in emerging market stocks.
Also speaking on the panel, he pointed to the current cyclically adjusted price-to-earnings ratio for emerging market equities of 11x, as compared to the long-term average of 16x.
Stadlmann cited Taiwan, Mexico and Poland as among the emerging markets where he sees value, while he is wary of India, Indonesia and South Africa.