Active investing in emerging markets

Emerging markets (EM) are in the midst of a structural transformation. As many EM economies have moved up the income chain, the composition of their equity markets has shifted, first toward manufacturing and then to services, with technology one of the fastest-growing sectors.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Meanwhile, the continuing integration of China into the global financial order, highlighted by the rapidly increasing weight of A-shares in the MSCI Emerging Markets Index, means increased liquidity and enhanced investment opportunities for EM investors.

But, by some measures, capturing alpha is becoming increasingly complex. In the past, many fundamental and quantitative EM managers were able to harness investment factors to deliver above-benchmark returns. As adoption of factors has become more mainstream, there has been a natural erosion of their ability to deliver investment performance. See the Decreasing efficacy chart.

Against this backdrop of increasing opportunity coupled with greater complexity in generating alpha, we turned to senior BlackRock investors from our systematic and fundamental EM active equity teams for perspective. Below, Gerardo Rodriguez and Gordon Fraser shed some light on how they attempt to deliver alpha today and what they think is in store for EM investors in the future.

Decreasing efficacy: Information ratio for style factors in emerging markets.

decreasing-efficacy

Source: BlackRock, July 2019. 756-day trailing IR (daily returns); no t-costs. Averaged across Momentum (+); Value (+); Growth (+); Size (–); and Volatility (–) from Barra GEM2 risk model for firms in SAE EM investable universe. Data covers January 2013 through July 2019. For illustrative purposes only.

Q&A: The new landscape in EM

Q: As investing in EM has grown both more complex and more competitive, how have your processes evolved?

Gerardo: When we first started investing in EM, almost all the data that was available to analyse came from the companies themselves, and it’s no secret that data is not always the most reliable. But in the past few years there has been an explosion in alternative data sources, so that we no longer have to rely exclusively on company information. This is true across developed and emerging markets, but given the rapid pace of adoption of digital technologies in the developing world, it’s really been a sea change for active management in EM.

There are many examples to cite—from using satellite imagery to track relative movement around manufacturing facilities to utilising natural language processing to see what employees are saying about their employers on career websites—but one that I’d highlight as particularly relevant to EM is geolocation data. We can use this data to measure the patterns of consumer footprints for each of the companies in, say the retail or banking sector, and use that information as a leading indicator for which of those companies is likely to report greater sales.

Gordon: The biggest change that we’ve made in the past few years has been to increase our use of a proprietary macro framework, so that it’s now a core part of our investment process. Given the increasingly heterogeneous nature of today’s EM landscape, we believe that it is imperative to track where each country is in the economic cycle and to monitor movement through the cycle using four key macro indicators: external accounts, fixed income, liquidity supply and economic activity. This allows us to consistently move capital out of countries we believe are in a later stage (activity surge) and into others that are in an earlier stage (healing). See the Macro matters graphic.

Macro matters: Four stages of the emerging market cycle and key macro indicators

Macromatters

Source: BlackRock, as at end February 2020, for illustrative purposes only, not meant to depict actual data.
Country placement is not indicative of where these countries are in their actual economic cycles.

Source: BlackRock, March 2020. For illustrative purposes only.

Country cluster chart

Source: BlackRock, March 2020. For illustrative purposes only.