An Emerging Markets Strategy That’s Always in Style
In EM, balance your style and let promising stocks lead the way.
Having one style may help you stand out in a crowd . . . until your style gets old. You need balance. The same could be said when investing in emerging market (EM) equities. To access the long-term opportunities of emerging markets while mitigating some of the risks, investors need an emerging markets strategy with a balanced approach to equity style where individual stock ideas can drive performance.
Some EM strategies with drawbacks:
- Benchmark aware – These strategies have country and sector weightings within set ranges of an index. They generally have a large number of holdings in order to achieve the targeted sector and country exposures. Risk and return of these benchmark-aware strategies can be driven by allocation (country/sector decisions) and factor exposures, sometimes unbeknownst to the portfolio manager. What happens to a portfolio that requires exposure to a sector that’s in line with the MSCI EM Index when that sector sells off?
- Style pure – By mandate or manager preference, these strategies are designed around either growth or value stocks. The potential problem with these types of strategies is that volatility can increase when the market experiences an abrupt style rotation, or ‘flips’ from growth to value (and vice versa). While this is not unique to EM, the reversals in EM can happen more frequently and more quickly than in developed markets (see chart below). The impact of these rotations can be amplified due to emerging markets having generally lower liquidity.
Style Rotations Can Happen Abruptly
MSCI Emerging Markets Value/Growth Return Spread, Monthly Style Performance in Emerging Markets (2018–2019)
Past performance does not guarantee future results
A balanced strategy can mitigate risk
An EM strategy that’s balanced by style can offer a way for investors to weather abrupt and frequent style rotations between growth and value stocks in emerging markets. A portfolio that’s constructed from three style baskets—growth, value and blend stocks—spreads risk across the style spectrum, potentially smoothing the return stream when one style is outperforming the other.
Portfolio construction creates opportunities
Emerging market equities are roughly split between growth and value, with variations cutting across and within sectors. EM stocks that are sensitive to interest rates, for example, are split 50/50 between growth and value. Thus, a strategy that diversifies across styles is able to take advantage of opportunities across the whole EM universe. Furthermore, there is a tendency for value and growth stocks to be positively correlated across countries and sectors, so benefits from diversification are more a function of style mix (blend of growth and value) and not how much country or sector exposure a manager has in their portfolio.
Best ideas drive results
A strategy that’s focused on style balance has the benefits of diversification baked in. This enables the strategy to build a concentrated portfolio of best ideas instead of having to diversify through a variety of countries and/or sectors, as seen with benchmark-aware strategies.
Having an individual style can hold you back when that style gets old. Add some balance to get in front of the crowd.