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Excess returns from active equities managers in emerging markets have declined steadily for more than 15 years and, while fees have come off too, mainstream managers should look at further reductions, according to Frontier Advisors.

In its latest research note, ‘Active Management in Emerging Markets’, Frontier says the investors could consider emerging markets (EM) small caps too, although this is not recommended as a substitute for the entire EM equities exposure.

The authors, principal consultant and head of equities Fraser Murray, and associate Rachel Mohr, even say that with the decline in alpha, on average, passive investing in the asset class has become more attractive.

They say there has been a structural change in emerging markets, with the weight of money and increased efficiency of the markets reducing opportunities to add value. Brokerage coverage and the number of investment products have more than tripled in that time. Average analysts’ coverage has gone from about one-third that of coverage of the MSCI World stocks in 2000, to match the bigger companies’ coverage by 2008 and subsequently plateauing to remain slightly ahead through 2019.

Other changes in the past 20 years include: greater investment by quant- driven investment approaches; an increase in passive investment; and. the creation of ETFs.

The telling point in the research note is that, using eVestment data, the MSCI EM index numbers and a manager universe ‘cleansed’ by Frontier, even the upper quartile cohort of managers has not beaten the index for 20 years, on a pre-fee rolling five-year basis. In that time, the upper quartile managers have gone from an average return of 4.9 per cent in the five years to 2005 to 3.3 per cent in the period to September 30, 2020. Over the same four five-year periods the index has shown positive 6.9 per cent, 11.3 per cent, 4.0 per cent and 4.2 per cent.

Nevertheless, the authors say: “We still believe active management data supports the justification for active management in emerging markets, despite the decline in alpha observed over time. Factors that should prove positive for active management over time include:

• China A-shares being progressively added to the MSCI Emerging Markets Index over the next decade – this market is dominated by retail investors and is highly inefficient

• There remains considerable opportunity for active managers to take off-benchmark positions in small caps and frontier markets that are not included in the MSCI EM Index, and

• Meaningful secular trends such as disruption, climate change and demographics are likely to be impactful on individual company outcomes.”