Home / The case for better implementation in emerging markets

It is amazing that a debate continues between passive and active management, nearly 40 years after its emergence in Australia with the arrival of State Street and Russell Investments to these shores in the mid-1980s.

Nevertheless, it does.

The really odd thing is, in emerging markets at least, the debate is still worth listening to. This is because managers with a bias to passive management tend to be very good at implementation. And emerging markets are rife for exploitation with their implementation inefficiencies, such as high transaction costs.

Tim Atwill, the head of investment strategy in Seattle for implementation specialist manager Parametric, said on a visit to Australia last week that each of the broad passive and active strategies, with respect to emerging markets equities, had issues. The trick was to combine the best of both in an investor’s portfolio, he said.

Atwill said that, mathematically, equal-weight portfolios across countries tended to be better than cap-weighted portfolios. But, managers which moved away from that could add further value through implementation efficiencies.

“If you ever wanted to use an implementation specialist, emerging markets is the place to do it,” he said. The three main considerations were:

• opportunity set within each market
• liquidity, where some have very high concentrations of shareholdings, and
• access, where some, such as China have quotas.

Atwill said that Parametric tended towards using equal-weight portfolios, with an overlay of “liquidity tiers”. The firm, however, does not take views on markets or tilts within markets. It concentrates on adding value through its superior techniques with transactions, tax management and other implementation processes.

Raewyn Williams, Parametric managing director, research, in Australia, said that super funds were tending to go “up the risk curve” of late in the search for yield, including with equities. This meant that they were looking to increase their emerging markets exposures.

“About 50 per cent of the world’s GDP, in purchasing power parity terms, is now in emerging markets,” she said.

But that does not mean that emerging markets will perform well from a market-return point of view, at least in the short term. That refers to the long-term underpinning of the asset class.

Atwill said that Parametric, which is best known in Australia for its after-tax efficiency strategies, such as centralised portfolio management (CPM), had been investing in emerging markets since 1995.

“So, we have a lot of institutional clients,” he said. “In the US they are seeing the emerging markets world in one of two ways: either they have a core, long-term emerging markets holding, usually with just one manager, or, usually for the bigger funds, they have a few managers based on investment styles, such as value…”

Parametric did a piece of research for one big Australian international investor which showed that there was the same benefits from CPM in emerging markets as there was in developed markets.

One of the attributes of Parametric’s emerging markets portfolios, Atwill said, was that they had a relatively low turnover – averaging about 12 per cent. The average for an active emerging markets manager is more than 50 per cent.

Transaction costs in emerging markets tend to be a lot higher than in developed markets.

Because of its equal-weighting bias, the Parametric strategy, Atwill said, was increasingly used as a “pairing strategy”, for other managers which tended to have a China bias.

“We won our first big Australian [super fund] client on this basis last year,” Williams said.