Confined to a limited investment universe, many passive EM strategies have a less competitive performance record than you might realize.
In contrast, active management can offer superior performance. We show in a recent paper that active strategies outpace passive in emerging markets more often than you might realize.
It’s true that passive investing offers many enticing features for investors. Most strategies focus on specific index benchmarks.
Investors can seek to earn returns close to those of the index, minus expenses. This formula works in many cases. Passive strategies have outperformed a majority of active managers in many investment categories.
The formula does not work so well in the emerging markets (EM) category.
A closer look at performance reveals that low-fee active managers have largely outperformed passive strategies in EM.
Active managers can choose better investments
Passive strategies tracking an EM index are limited to a narrower investment universe than active management strategies. (An investment universe is the range of securities in which a portfolio can invest, as defined by its prospectus). Index providers have not necessarily selected stocks with the most attractive return potential.
Active managers have the flexibility to invest in a wider opportunity set, both within and outside the index. In selecting stocks, attractive return potential matters to an active manager.
Our analysis indicates that the investable EM universe is almost 100% larger than the MSCI EM Index that is the basis for many ETFs.
We believe a larger investment universe generally gives active managers advantages. They can cast a wider net, and balance out the variety of opportunities in emerging markets.
An inefficient sector
In general, we believe EM are both more dynamic and under-researched compared with developed markets, providing opportunities for managers who can do cost-effective research to outperform indexes.
EM equity is one of the least efficient sectors of the market and low-cost active managers have generated superior performance relative to their passive counterparts.
Explore more research
A deeper look into cost reveals that actively managed strategies are more competitive than passive strategies in EM. For a more detailed look at our research, read Putnam’s latest paper.
For informational purposes only. Not an investment recommendation.
This material is provided for limited purposes. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Putnam product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice. The opinions expressed in this article represent the current, good-faith views of the author(s) at the time of publication. The views are provided for informational purposes only and are subject to change. This material does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Investors should consult a financial advisor for advice suited to their individual financial needs. Putnam Investments cannot guarantee the accuracy or completeness of any statements or data contained in the article. Predictions, opinions, and other information contained in this article are subject to change. Any forward-looking statements speak only as of the date they are made, and Putnam assumes no duty to update them. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those anticipated. Past performance is not a guarantee of future results. As with any investment, there is a potential for profit as well as the possibility of loss.
Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
Putnam Retail Management.