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Matthews Asia: Why active management offers better returns in the fast-growing Asian economies

07 August 2017

Portfolio strategist David Dali explains how active management can mitigate risks of the under-researched emerging Asia markets.

By Rob Langston,

News editor, FE Trustnet

With low coverage of stocks in some of Asia’s fastest growing markets, passive investors could be missing out on strong growth stories, according to Matthews Asia portfolio strategist David Dali.

Dali said while traditional emerging markets have provided solid returns in the past, their economies have changed.

While some have done so in the right way and are more developed, others have failed to enact reforms needed to sustain high growth levels.

“In 2016, the weighted average GDP growth rate of countries within the MSCI Emerging Markets index fell to roughly 3.5 per cent, from over 8 per cent in 2007,” he said.

“Removing China and India, the weighted average growth for the rest of emerging markets fell to just above 1 per cent in 2016 – not an attractive metric.”

Performance of MSCI Emerging Markets in 2016

Source: FE Analytics

As such, Dali said the benchmark and the exchange-traded funds (ETFs) that track it now hold substantial allocations to the high growth countries of the past instead of the next generation of economic leaders.

He said the 10 richest emerging market economies – representing almost half of the index – grew in aggregate by 1.61 per cent in terms of GDP per capita.

“In contrast, what we call the ‘Next 7’ – fast growers in Asia including India, Indonesia, Vietnam, Pakistan, Bangladesh, Sri Lanka and the Philippines – had GDP growth in aggregate of 5.93 per cent,” said Dali.

However, investors looking to access these fast-growing economies may struggle to gain exposure through passive vehicles.

He added: “The MSCI Emerging Markets index is now approximately 70 per cent Asia. So maximising an allocation to emerging markets requires ‘getting Asia right’.

“We believe that an asset allocation that favours the next generation of growth countries, while not being constrained by backward-looking benchmarks, can be additive to any emerging markets allocation or even serve as a stand-alone growth investment.”


The portfolio strategist said those that invest in funds tracking broad emerging markets indices may find it difficult to take advantage of the investment opportunities they present.

Dali said: “Investors today have the choice of using active managers or ETFs to gain exposure to almost any asset class.

“Research shows that active managers have more difficulty outperforming benchmarks in larger more developed markets (with the exception of Japan).

“One reason is that a higher percentage of stocks within developed market benchmarks are covered by sell-side analysts.

“In other words, developed market stocks, especially in the US, tend to be well-researched with data that is widely disseminated among market participant. Therefore, few managers have an ‘information edge’.”

He said 95 per cent of stocks in the MSCI EAFE index – which tracks developed markets excluding US and Canada – have sell-side analyst coverage, while more than 90 per cent of MSCI Emerging Market stocks are covered.

However, for companies in Next 7’ coverage is lower, according to Dali. He said the Next 7 markets include approximately 7,519 stocks – 2,801 of which have a market cap above $25m – yet, more than 46 per cent have no coverage.

Performance of Next 7 markets over 5yrs

Source: FE Analytics

“This means most stocks in Next 7 markets do not appear in benchmarks and are undiscovered,” he explained.

“This scenario is dramatically different in the US and other developed markets (with the exception of Japan).

“Active managers willing to do the groundwork can find undiscovered companies that have very favourable attributes vs. their well-researched benchmark counterparts.

Dali said one of the other benefits of active management in this part of the market is management of risk. One such risk is liquidity management, given the size of these markets, smaller market caps and low trading volumes.


“While we believe that market liquidity will continue to improve, we acknowledge that liquidity risks are significant and require constant attention through active management,” he explained.

Elsewhere, political risk can also be a concern in emerging markets for investors. Dali said while it can be difficult to quantify and harder to predict in emerging Asian economies, active stock selection can offset some of the risk.

“The perception is that smaller, less developed economies have more corrupt governments, less corporate governance, more social unrest, and are less stable overall,” he said.

The portfolio strategist said given the developing nature of the economies, companies listed on exchanges tend to be those focused on “basic necessities” such as food, clothing, healthcare and other consumer durables.

“Companies providing basic goods and services tend to have fewer regulatory pressures and fewer unforeseen politically motivated surprises—with the exception of infrastructure and utility-related businesses,” he said.

“Therefore, active management may be able to mitigate significant political risk in emerging and frontier Asia by simply avoiding companies and sectors that are subject to heavy political scrutiny.”

Furthermore, exposure to the emerging Asian economies not included in broad emerging market indices can also offer investors uncorrelated returns and more diversification.

He added: “Price movements, especially in countries like Bangladesh, Vietnam, Sri Lanka and Pakistan, have exhibited very low correlation to the S&P 500 index, the MSCI EAFE index or even broad emerging markets.”

“There are several examples in recent history whereby US/European stocks exhibited downside pressure yet Asian frontier markets were stable or largely unaffected.”

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