Does Active Management Add Value In Emerging Markets?
May 24, 2016
by Larry Swedroe
Charlie Munger’s Cancer Surgery Formula
I continue my series on the ability of actively managed funds to add value for their investors with an in-depth look at the asset class that is the “poster child” for an inefficient market – emerging markets. Can active managers outperform a passive index, given the supposed abundance of mispriced emerging-market stocks?
For instance, in a recent Wall Street Journal article on the subject of emerging markets, columnist Michael Pollock wrote: “Managers of active funds can make distinctions among that huge range of stocks that an index-tracking fund doesn’t make.” Pollock quoted Jan Van Eck, chief executive of VanEck, who believes there are compelling arguments for active management in an emerging markets fund. According to Van Eck, whose firm manages the VanEck Emerging Markets Fund (GBFAX), with each of the countries in the category at a different point in its development cycle, “you absolutely don’t want to have exposure to all countries at all times.” He went on to add that “there are a lot of junky companies included in indexes.” Thus, “you want someone who can shift the company, [industry] sector and country exposure over time.” Van Eck concluded: “If you want to have one fund for emerging markets, active is the way to go.”
This story about active managers and their ability to win in “inefficient markets,” such as emerging markets, is one I hear all the time. With that in mind, I’ll turn to my trusty videotape.
Consistent with the analysis I performed in my article on international small-cap funds, to keep the list to a manageable number of funds, I’ve chosen to examine the performance of the 10 actively managed emerging market funds with the largest amount of assets under management as of the end of 2015. And then, as before, I’ll expand the analysis to include the entire universe of funds that survived the full 15-year period I used for my evaluation.
To ensure that I examine long-term results through full economic cycles, I’ll analyze the performance of funds over the 15-year period ending December 31, 2015. Furthermore, when there is more than one share class of fund available, I’ll use the lowest-cost shares that were obtainable for the entire period.
As I noted in the article on international small-cap funds, this methodology creates a substantial bias in the data. I am considering only funds that survived the full period, and a significant number of actively managed funds disappear each year. Second, the AUM of a fund that has beaten its benchmark will not only benefit from that strong performance, but it will also benefit from the investor cash flows that tend to follow. Thus, the funds with the strongest past returns will tend to be the largest.
This doesn’t mean, however, that investors actually earned the same returns over the full period, since they may not have been invested over the entire term. Therefore, the results are not truly reflective of what investors in these actively managed funds actually earned – they are biased upward.
We should expect funds with the largest AUM to have outperformed, although the research demonstrates their large asset size is likely to hinder future performance. Thus, the real questions I’ll answer are the following: First, if you were smart or lucky enough to identify these 10 stellar performers ahead of time, by how much did you benefit versus using passive alternatives? And second, was it worth the risk that you might have been wrong in your selection?
Keeping the aforementioned bias in mind, the table below shows the performance data for the 10 largest actively managed emerging market funds as of year-end 2015. My standard practice is to compare the returns of these funds to the returns of comparable funds (based on their Morningstar categorization) from the leading provider of index funds, Vanguard, and a prominent provider of passively managed structured asset class funds, Dimensional Fund Advisors (DFA). (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios).
I should note that DFA funds can be purchased through some 529 and 401(k) plans but, generally, are available only through an advisor. An investor would incur fees from that advisor; those fees can vary greatly (in some cases they are very low) and cover the full range of financial planning services the advisor provides. Also, John Hancock recently introduced a series of ETFs that are managed through DFA (with expense ratios that differ from the DFA funds cited in this article). Those ETFs can be purchased directly by investors. All Vanguard funds can be purchased directly by investors.
While my preference is to use live funds as benchmarks (so that we can see realizable returns, after implementation costs), because neither Vanguard nor DFA offers an emerging-markets large-growth fund, I’ve used the MSCI Emerging Markets Growth Index as the benchmark for this asset class.
The returns data in the table below covers the 15-year period ending December 2015.
Does Active Management Add Value In Emerging Markets?
The following is a summary of the results:
- In the large-growth category, relative to the MSCI index benchmark, all six of the actively managed large growth funds outperformed. The average outperformance was by 1.5%.
- In the large-blend category, both active funds outperformed the comparable Vanguard fund by an average of 1.4% and the comparable DFA fund by an average of 1.1%.
- In the large-value category, both active funds underperformed the comparable DFA fund by an average of 1.0%.