Emerging markets have been on one heck of a roll over the past few quarters, with both equity and debt flourishing. They’ve been leading the global equity benchmarks since the beginning of 2016, and emerging market bonds have delivered some of the most robust returns found in fixed income outside of high yield corporates.
The MSCI EM Emerging Market equity index is up an impressive 31% over the past 17 months, while the hard and local currency debt indices have both posted 17% gains.
We’ve also witnessed a few pivotal moments this year, one example being Citigroup’s March announcement that it would include the onshore Chinese debt market in a selection of its emerging market debt (EMD) indices.
Given that it is the world’s third largest debt market, behind the US and Japan, at more than $8 trillion, there are many who feel it is about time.
EMD riding for a fall?
Of greater significance, perhaps, is Argentina’s decision to offer up its first 100-year bonds. This could well be EMD’s canary in the coal mine, sending a signal that the sector is getting overheated and is heading for a pull back.
After all, 100-year bonds are extremely rare, especially among emerging markets. According to M&G Investments there are only 15 emerging market issues with this maturity.
Last but not least, at the time of publication MSCI had just included Chinese A-shares in its emerging market index. Although it’s a slightly watered down version of the whole A-share market with just 222 stocks, it is still another significant milestone for emerging markets.
This inclusion of Chinese investment markets is obviously being driven by index providers’ need to meet passive investors’ insatiable demand for newer, more complete indices.
I for one think this is a good idea – the more indices the better active fund managers can be benchmarked.
I’ve written before about the disparity of asset flows into passive over active products in emerging markets during this rally, and I still believe it is not a good idea for long-term investors to follow this trend.
Over five years around 46% of fund managers outperform the index and a further 17% of the field outperform the best ETF.
However, only 31% (96/305) of the peer group have managed to keep pace with the index over the year until the end of May, with just 3% outperforming the ETF.
This is often the case during pronounced rallies: as the saying goes a rising tide lifts all boats. It is during a market correction that an active manager really proves their worth.
There has been a much better showing from hard currency EMD managers over the past year, with 61% (62/102) returning more than the JP Morgan EMBI Global Diversified index’s 9.8% gain. This is while in the local currency sector an impressive 79% (26/33) of managers have positive information ratios.