If you are an avid reader of the financial press, you will not be surprised by headlines stating that passive investing is leading the way, with active investing trailing behind.
Money Marketing is far from immune from such stories.
In June, we pointed out that passive funds were dominating Morningstar’s managed portfolios landscape.
Later in September, we reported a decline in managed portfolios labelled as active, again according to research from Morningstar.
In October, independent consultant Mark Dampier, writing for Money Marketing, said: “Active is caught between high costs of regulation and new business rapidly disappearing to the passive industry. Simply put, passive funds have slaughtered most active funds, especially over the past 15 years or so.”
The EM landscape as a whole is more conducive to active management and creates a great environment for active investors
However, to say that passive is always the best way forward while investing is simply not true. Numerous financial professionals argue that there are areas where maintaining an active stance for investment works best.
‘Great environment’
One such pool that has remained attractive to active investors is emerging markets (EM).
The EM investment landscape as a whole is “more conducive” to active management and creates a “great environment” for active investors, according to Ninety One co-head of EM Sovereign & FX Grant Webster.
He adds that, the further you move away from the S&P 500, the “more opportunities” there are for active.
In both 2023 and 2024, most active EM managers outperformed their passive counterparts
Webster describes the EM universe as “incredibly wide”, adding that it contains “numerous geographies” that present plenty of opportunities to actively invest.
Even in a shrinking EM economy, better investment prospects can be accessed via active investing, he explains.
Another advantage of maintaining an active approach when investing in EM is that it provides the investor with more options, or ‘levers to pull’, compared to passive investing.
Webster predicts this trend will not change, with active continuing to be a favourable form of investing in EM.
Templeton Emerging Markets Investment Trust (TEMIT) lead portfolio manager Chetan Sehgal also believes that active investing in EM yields stronger results, with TEMIT proving this point. He says EM is “diverse and at different phases of growth”, which allows experienced active managers “to have the opportunity to identify these trends and possible winners ahead of passive funds”.
Numerous EM firms have scope for corporate governance improvement as well.
An active manager can react and adapt
Sehgal says “active managers can engage with some of these companies to bring about positive changes, which can be an additional source of alpha generation”.
As the funds are active and not passive, the managers of these investment vehicles “are better placed to determine” which companies will succeed over the long term, and which to avoid, says Sehgal.
This approach to EM reduces downside risk and enhances risk-adjusted returns.
‘Diversifying better’
Sehgal adds that EM active managers have the advantage of “being able to diversify better, allocating exposures as appropriate depending on the investment climate, rather than being bound by an index”.
The MSCI EM Index has returned 7.45% annualised since its launch in December 2000. This is higher than global equities represented by the MSCI World Index, which has returned 5.44%.
Russia coming out of the EM index was painful
However, the actively managed TEMIT has delivered an 8%–10% rate of return.
The EM space is reaping investment rewards as, according to the International Monetary Fund, EM economies generate 65% of global growth.
When it comes to investing in EM, it is not just that active offers better results than passive but that the EM indices themselves create issues for passive investors.
Morningstar associate director of manager research Lena Tsymbaluk says the biggest concern for passive funds tracking the MSCI EM Index is that it is too concentrated.
Tsymbaluk states that China, India, South Korea and Taiwan “account for about 75% of the total portfolio weight”, as of 30 September 2024.
Active managers in the area have the flexibility to either concentrate their investments or diversify their selections, all while conducting fundamental research to support their allocation decisions.
When China rallied in September, passive funds incorporated the full upside and made it more challenging for active managers to outperform
Another concern is political risks, particularly when Russia was removed from the EM index because of its invasion of Ukraine in February 2022.
Russia had been labelled as an EM but, due to the sanctions imposed following the invasion, it was removed from the index.
As Sehgal says, “Russia coming out of the index was painful.”
However, Ninety One co-head of global EM corporate debt Alan Siow points out that, while an EM exchange-traded fund (ETF) can give you exposure to an area you do not want to invest in, such as Russia, “an active manager can react and adapt to this”.
Also, because there is less liquidity in EM, ETFs tend to find it harder to replicate EM indices, according to Walker Crips business development manager Alan Kinnaird. He says the returns can be “quite different” from the EM benchmark.
Experienced active managers have the opportunity to identify trends and possible winners ahead of passive funds
They could offer a 10% return on investment (ROI), whereas the EM ETF offers only 9%.
In comparison, a FTSE 100 ETF will deliver the same as the FTSE 100, Kinnaird explains.
As Aviva says, “Investing is recommended for the longer term with the aim of building your wealth over years,” so an ETF that offers only 9% ROI when the index offers 10% can make a sizeable difference over many years.
The China question
Tsymbaluk emphasises that, in both 2023 and 2024, most active EM managers outperformed their passive counterparts. She says this is because active managers have been strategic about their country allocation.
However, “when China rallied in September, passive funds incorporated the full upside and made it more challenging for active managers to outperform”.
Even in a shrinking EM economy, better investment prospects can be accessed via active investing
Tsymbaluk adds that China’s rally greatly benefited passive funds. However, questions have been raised about how long this rally could last.
In late September, China’s central bank announced the most dramatic stimulus measures since the Covid pandemic, which reduced borrowing costs to boost the property market.
China’s CSI 300 Index and Hong Kong’s Hang Seng both rallied, but analysts are enquiring about what the Chinese government plans to do next, with questions around whether the rally still has legs.
To have a chance of continuing, the Chinese government must deliver further fiscal stimulus, says Malaysian Asset Management Berhad (AHAM Capital) assistant portfolio manager Yip Kah Ming.
Later in November, the Chinese government announced a further US$1.4trn package over five years to tackle debt — but not a fiscal stimulus.
Macquarie chief China economist Larry Hu says: “We don’t expect policymakers to increase stimulus this year, as they need to know more about the new US trade policy.”
EM is diverse and at different phases of growth
Saxo chief investment strategist Charu Chanana says, on the Monday after China’s November package was announced, the Asian market dropped, due to the focus on defusing local government debt risks. The package boosted neither consumption nor the property market.
Regardless of what the second-biggest economy does next, and despite the deluge of ‘Passive outperforms active’ headlines, this does not represent EM.
For investors to derive a greater ROI while investing in EM, it is crucial to remember that, ‘Active outperforms passive.’
This article featured in the December 2024/January 2025 edition of Money Marketing.
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