A few weeks ago, I wrote here about the rip-roaring start emerging markets have made in 2017. However, with the de facto investment choice for exposure being passive, I have decided to look into what investors are missing out on with that decision.
To say global emerging markets is a broad church is something of an understatement – there are more than 800 stocks from 28 countries in the large-cap emerging markets index. Each company is at the mercy of entirely different political and environmental risks, and micro and macroeconomic factors. Not to mention the corporate governance issues that can catch even the most seasoned managers by surprise. A large team and plenty of patience is often required to triumph here.
In the chart below, I’ve looked at the average allocations of all managers tracked by Citywire in the US versus only those managers who’ve added value over three years, and compared those holdings with the index.
All manager allocations vs. outperforming managers vs. index allocation - Dec 2016
China, in or out?
The first thing that is really striking from the data is the underweight allocation to mainland China. The average of all managers stands at a 9.3% underweight, and those who have outperformed at 8.1% under. Much of that weighting is made up by an off-benchmark allocation to Hong Kong, with both groups holding 5.2% in Hang Seng-listed companies. Nevertheless, it is still less than the index and when Taiwan is factored in, to give the managers’ Greater China exposure, it is a gap that only widens.
On the surface, they don’t like China. The curious thing, though, is that fund managers have on average increased their allocations to mainland China since the mid-point of last year. On a performance-adjusted basis, allocations for all managers have increased by 1.3%, while outperforming managers have upped their allocation by 2.1% since June.
For those looking to go big into China, look no further than the Principal Origin Emerging Markets fund, which has a whopping 41.2% in the mainland and a further 18.3% in Taiwan. The rated manager with the highest allocation is Allianz’s A-rated Michael Heldman, who has a more modest 29.5% allocation.
But what about the other two emerging markets dominating headlines at the moment?
First up, Russia. Both groups of managers are overweight the country, though allocations have risen in line with the rapid appreciation in the domestic equity market over the past year. However, the top performing managers have larger positions in the country, which goes some way to explaining why they have added value over this period.
The Rational Risk Managed Emerging Markets fund, managed by Mike Newton, Edward Baker and Mathias Wikberg, has 12.9% invested in the country, more than three times the market weight. AllianceBernstein’s Laurent Saltiel is the rated manager with the largest chunk in the divisive country – his AB Emerging Markets Growth Portfolio is at 10.7%. He has an A rating.
Second, both groups of managers have overweight allocations to Mexico. As with Russia, and perhaps rather surprisingly, allocations didn’t move much in both camps over the turbulent fourth quarter of 2016.
Goldman Sachs’ AA-rated Prashant Khemka is both the rated manager with the highest allocation and the individual with the highest allocation overall in the sector. A punchy 18.4% of the Goldman Sachs N-11 Equity fund is tied up over the border. This is a long-standing position in the fund with key stakes in Walmart Mexico and beverage company Fomento Economico Mexicano. Adding to this portfolio’s intrigue is the equally impressive position in Korea of 27.4%. It is extremely rare to find a manager with even a market share weighting in Korea – with most citing governance concerns – let alone nearly double the index. He’s one I’ll certainly be keeping an eye on as the fragile emerging market recovery develops.
Who's betting big on...
All holdings as at December 31 2016, bar those with asterisks, which are November 2016.
†The manager ratio is the average information ratio of the funds the manager has run in this sector over the past three years. A positive figure means the manager has outperformed their benchmark(s).