Investing in emerging markets: are investment funds a smarter buy than trackers?
November 20, 2023
3 minutes to read
The US financial markets are known all over the world as the largest, most liquid markets with the highest capitalisation. They are also the most efficient. As they have so many market participants – buyers and sellers – you can assume that the price you pay for a share takes into account all available information about that company, the industry, the economic context, interest rate policy, and so on. In other words, the price of a share is immediately adjusted based on all available data. As soon as any bad news emerges about a company, for example, investors immediately take this into account, which causes the price to fall almost straight away.
Looking for hidden gems?
According to this efficient market hypothesis, investors may find it difficult to gain an information advantage. Achieving better investments than the rest of the market (= all those other millions of investors) by identifying unknown patterns or benefiting from undervalued shares is virtually impossible. There are no hidden gems to be found on the stock market precisely because so many other investors have access to the same information at the same time. The market identifies all opportunities immediately, after which the shares are adjusted.
Passive vs active management: 1-0 This efficient market hypothesis also seems to be reflected in the figures: roughly 97% of actively managed funds have not managed to beat the US markets over a 20-year period. Historically, it is therefore smarter for long-term investors to opt for passive management. In other words, it is better to simply track a broad-based index such as the S&P 500 than opt for an investment fund that is trying to outperform the S&P 500.
Better opportunities in emerging markets?
The prevailing logic is that emerging markets are far less efficient. The markets are smaller in size, with smaller volumes being traded, fewer market participants, fewer analysts, less information available, and so on. This means there is more scope for active investors to exploit an information advantage and therefore beat the market. This is why people say that in theory, the opacity of emerging markets therefore generates more opportunities for those who are willing to dig deeper, look beyond the available figures and rtruly understand the dynamics of local markets.
Costs, volatility and geopolitical risks
However, there is a pitfall lurking in this mindset. The assumption that inefficiencies automatically result in higher returns for active investors and fund managers ignores the complexity of these markets. The risks are higher and the costs of obtaining and processing information are also significantly higher. Active management also requires strong discipline and a clear strategy to avoid being sucked into the volatility that sometimes characterises these emerging markets. The geopolitical risks also appear to be higher in those emerging economies. An example of this happened in March 2022, when Russia was removed from the emerging market indices, which meant asset managers had to write off these positions.
Passive vs active management: 2-0
The idea that active management works better in emerging markets also doesn't appear to be confirmed by the figures. Although the success of active managers varies from country to country, the fact is that passive management certainly doesn't perform less well in these inefficient corners of the market. Quite the opposite is true, in fact. Around 95% of actively managed funds aimed at emerging countries fail to beat their benchmarks in the long term (20 years). Research by Morningstar also shows that active managers tend not to achieve their targets over a ten-year term. Only 20% of active managers in the emerging market equity category still exist after ten years and are outperforming the index. The chance that you can beat the market with active management is therefore limited, both in so-called more efficient markets (US and also Europe) and inefficient markets (emerging economies). If you still wish to take your chances with active management, you need to take into account certain obstacles as well. Knowing that the vast majority do not reach their benchmark in the long term and being aware that nothing or no one can guarantee that a high-performing fund will continue to do well, which fund should you choose exactly?
Investing with trackers or funds? At Keytrade Bank, you choose what you invest in