An article in Barron’s discusses how factor investing hasn’t taken on in emerging markets as much as in other asset classes, adding that “investors shouldn’t overlook the opportunities.”
The article cites Morningstar data showing that ETFs are more heavily invested in developed countries than in emerging ones, but highlights research conducted last year by the Dutch asset-management firm Robeco showing that a portfolio favoring value and momentum stocks within the MSCI Emerging Markets Index generated an annualized return of 16.7% (from 1988 through 2017) compared to the broader index which returns an average of 11.4%.
But the article argues that investors seem to be staying on the sidelines, citing the following reasons:
· Emerging markets in general have lagged developed countries in recent years.
· “Active managers have performed well in the developed world, giving investors less reason to shift away from bottom-up stock picking, as they have in the U.S.”
· Liquidity: In smaller markets, shortages of buyers and sellers can “leave large gaps between bid and offering prices.” Since ETFs are required to rebalance on certain days a few times a year, this can hurt their returns.
· Investors may be worried about account fraud and lower data quality in emerging markets. According to Robeco portfolio manager Jan Sytze Mosselaar, prices can be manipulated by insiders of government interference instead of by market dynamics, adding, “We exclude a lot of stocks from our investment universe because we do not trust the data.”
The article concludes, however, that “the long-term benefits of factor investing remain. As more investors come to understand factors better, emerging markets will likely be the next battleground for smart-beta strategies.”