The US fund manager Parametric has drawn up a five-point checklist to assist superannuation funds targeting returns from emerging market equities.
Parametric’s Australian Managing Director, Research, Raewyn Williams, says super funds need to keep the best and avoid the worst of active and passive emerging market investment strategies, and this checklist, based on a number of the firm’s published research papers, will help funds achieve this goal.
“At a time when some super funds are increasing their weight to emerging market equities in a search for higher returns, what makes a good emerging market investment strategy is a question well worth asking.
“Many emerging market fund managers are capacity-constrained, so as super funds look for new managers and strategies it’s worthwhile revisiting what makes for an effective exposure to these equity markets.”
Williams says there are well-known deficiencies with traditional active and passive approaches to emerging market investing.
“In the past, it seems that many super funds have just been content to accept these deficiencies as part and parcel of investing in these markets.
“Super funds owe it to their members to do better than this and should look for an approach that seeks to capture the best of active and passive strategies while bypassing the negatives. This is why Parametric has devised a five-point checklist to provide a foundation stone to build a higher-performing emerging market portfolio.
“It is a tool offering practical insights and suggestions to give super funds the capacity to avoid the pitfalls of investing in these markets.” They are:
1. Avoid under-diversifying – Diversification is a rare “free lunch” for portfolios, but a typical passive emerging market portfolio (and many active portfolios) is not well diversified and can have high concentration risks;
2. Prioritise country selection – The only broad risk that is really important to manage in emerging market portfolios is country selection; other risks matter less so managing them is second order. This is very different to the risks that drive developed market equity returns. The best “bang for your buck” fee spend in emerging markets is a strategy that prioritises country selection;
3. Stay unhedged – Currency hedging is not worth the effort – for philosophical and practical reasons. It can actually undermine what super funds are trying to achieve in emerging markets;
4. Focus on implementation – Emerging markets attract high transaction costs and super funds must look for fund managers who measure and manage these costs. High turnover emerging market strategies have a real headwind versus low turnover strategies because of these transaction costs; and
5. Favour transparency – Emerging markets are, by definition, a high-risk asset class and can deliver shocks, so super funds need transparency about what’s happening inside their emerging market portfolios. This again creates a headwind for active emerging market strategies that can be opaque “black boxes” versus simpler, rules-based emerging market strategies.
