A recent FE Trustnet study highlighted that only 15 out of a possible 43 actively managed funds in the IMA Global Emerging Markets sector have managed to beat the MSCI Emerging Markets index over five years.
Performance of sector vs index over 5yrs
Source: FE Analytics
The study made for even worse reading if you were to remove the highly-popular, but now soft closed, Aberdeen and First State funds as, without them, less than a quarter of active portfolios have outperformed the index over the period.
Deverell, investment manager at Equilibrium, tends to blend active and passive in both his client and personal portfolios.
However, due to the apparent lack of consistent outperformers in the sector, he only uses trackers to gain access to the developing world.“We’ve done quite a lot of research into the active versus passive debate and the strongest case for using trackers was in emerging markets,” Deverell (pictured) said.
“It’s quite counter intuitive really, because one of the major reasons why people say active managers underperform in the US is because it is such an efficient market. Emerging markets are often very inefficient so you would think active managers would have plenty of opportunities to outperform.”
It is not only FE Trustnet research which has raised questions over the ability of emerging market managers to consistently beat the market.
A recent report from S&P Dow Jones shows that most sterling funds invested in emerging markets have failed to outpace the market over one, three and five years.
“It is often believed that in less efficient markets, such as emerging market equities, active investing provides better results because of its ability to take advantage of perceived mispricings,” the report said.
“The results for emerging market funds dispel this myth, as the significant majority of funds - regardless of the currency denomination - underperformed the benchmark across all three time horizons used in this report.”
Though Deverell says there isn’t any definitive answer to why more active emerging market managers have underperformed than outperformed over recent years, he says it won’t all be because they are low quality.
“One of the only ways that would explain it is costs,” he said.
“If you look at the charges of emerging market funds, they do tend to be higher than UK-focused funds. That reflects the additional research that is needed and, like the facetious comment I made the other day, those charges will also probably go towards the fund manager’s flights.”
“However, not only have you got the higher costs from an ongoing charges point of view, there also the higher transaction costs. They have to pay bigger spreads and higher dealing costs than they would have to on the LSE.”
“If managers are being active and trading a lot, then it is going to cost them even more.”
Whatever the reason, Deverell has been a long-term supporter of Vanguard Emerging Markets Stock Index fund instead of using active managers.
According to FE Analytics, the £4.6bn fund has returned 64.88 per cent since its launch in June 2009.
That return is around 3 percentage points less than its benchmark, but it has had a tracking error of just 0.51 per cent over that time. It has also outperformed the sector average since launch.
Performance of fund vs sector and index since June 2009
Source: FE Analytics
The Vanguard fund has also had a tracking error of below 0.5 per cent over one, three and five year periods. A fund has a very low ongoing charges figure (OCF) at 0.4 per cent.
Through the fund, investors have exposure to China, Korea, Taiwan, Brazil, South Africa and India.
Its largest sector weightings are financials, information technology and energy.
Other passively managed funds in the IMA Global Emerging Markets sector include Fidelity Index Emerging Markets, L&G Global Emerging Markets Index and FP Henderson Rowe FTSE RAFI Emerging Markets.
Though Deverell has favoured trackers for his emerging markets exposure, he says that might not always be the case.
“We use the Vangaurd fund for our emerging markets exposure and we have done for a while now. We have looked at some of the active managers that exhibited some sort of consistent outperformance, like Lazard Emerging Markets and Skagen KonTiki funds.”
“It’s more of a hypothesis than anything else, but what you had prior to the financial crisis was a lot of the emerging market economies moving in the same direction; possibly because of the commodity super-cycle.”
“That boom seems to have ended and there seems to be dispersions in the way different emerging markets perform, which could mean there are more opportunities for active managers. The question is whether now is a good time to start looking at active emerging market managers again.”
Deverell told FE Trustnet earlier this year that he was keeping a close eye on the £4.3bn Skagen KonTiki fund as it is one of the few portfolios that has shown it can consistently outperform.
Though the fund sits in the IMA Global sector to give its managers greater flexibility, it is benchmarked against the MSCI Emerging Markets index.
According to FE Analytics, the Norwegian-domiciled fund has returned 711.38 per cent since launch in April 2002, beating the index by 452.09 percentage points.
Performance of fund vs index since launch
Source: FE Analytics
It has also beaten the index in nine out of the last 10 calendar years, the exception being in 2012 when it underperformed by 5 percentage points.
The Lazard Emerging Markets fund, which is managed by the long-serving James Donald, has been the only fund in the IMA Global Emerging Markets sector which has beaten the index in each of the last five years, as our study showed.
