Finance

Emerging Market ETFs Garner Unprecedented Investor Traction Amidst Global Dislocations

Emerging markets are the new frontier for those in search of playing the odds in an investment world rife with volatility. Digging into the niche of actively managed exchange-traded funds (ETFs) focused on these markets uncovers a burgeoning trend. In the vast ocean of the ETF ecosystem, valued at $348 billion, a mere 5% represents the slice of actively managed ETFs attentive to the developing nations. Yet, in the swirling tide of monetary inflows over the past year, they have captured an impressive one-third of new capital influxes and a staggering 50% in the past month alone, as per data accrued by Bloomberg.

The Moment is Ripe for Active Management in Emerging Markets

Donald Calcagni, the Chief Investment Officer of Mercer Advisors Investment Management, reinforces this trend. Amidst the global economic shifts and imbalances, Calcagni advocates for a structured active management approach. He cites the conspicuous global dislocations, the alluring valuations, and the intensifying concentration of markets as pivotal factors accelerating this investment shift.

The emerging market shares offer a stark contrast in evaluations compared to their American counterparts. Based on Bloomberg's collated data, these stocks are trading at nearly a 43% discount, hovering just below the largest historic valuation gap. The Wall Street cognoscenti, even those with minimal foreign investments, interpret this chasm as an unmistakable sign that these stocks are undervalued, thus setting the stage for investors to seize the moment and stock up.

Leveraging Emerging Assets with Strategic ETF Investments

The allure of ETFs betting on emergent assets lies in their ability to provide reduced fees and eliminate the complexities surrounding cross-border trading. This increasing affinity revives the debate concerning whether investors can derive more substantial returns from dynamic, active strategies as opposed to passive ones that faithfully trail a benchmark.

Patrick Maynor takes center stage in this narrative as the head of equities and a portfolio manager at Trusted Capital Group. His initiation into emerging-market funds began with a foray into the Avantis Emerging Markets Equity ETF (AVEM) in April 2023. This move has proven advantageous as this ETF has garnered a total return nearing 13%, surpassing its benchmark by 3 percentage points since inception.

Maynor draws attention to the latent value nestled within developing equity markets, noting the relatively modest pricing compared to mature economies. Beyond attractive valuations, these investments also render diversification for his firm's substantial $7 billion in managed assets. An initial allocation of 15% of his global equity strategy portfolio to AVEM is set, with prospects of increasing this share tactically over time.

The complexity of investing in emerging markets (EM) was not lost on Maynor, who opted for collaboration with experts in the field. The challenging investment landscape led him to lend greater credence to active management's necessity.

Unprecedented Interest in Actively Managed EM ETFs

In the last year, American Century Investments' Avantis Investors and Dimensional Fund Advisors have magnetized over 95% of cash flows directed towards actively managed EM ETFs, Bloomberg reports. The products from these financial powerhouses boast lower industry fees and have delivered a performance that eclipses passive benchmarks, challenging the skeptics of active management.

Active EM ETFs: Lower Fees, Strong Performance

Prompted by this thriving investor interest, new market entries are amassing. U.S. markets have witnessed the introduction of roughly 27 new emerging-market ETFs since the dawn of last year, with at least 18 adopting an active management stance, the figures from Bloomberg illustrate.

Take AVEM, for instance, an exemplar of lower fees charging a modest 33 basis points, which is less than half of the industry's average hovering around 70 basis points for U.S.-listed active ETFs focused on developing nation assets. The strategic moves have been fruitful, with the fund's returns exceeding 15% in 2023, while its benchmark trailed at 11.7%, courtesy of Avantis' performance data.

Yet, AVEM's proficiency does not falter in adversity, maintaining a 19% asset allocation towards China, where equities face headwinds. Similarly, Dimensional's offering in the EM spectrum leans towards smaller companies and value stocks, while still substantial in Chinese exposure, as highlighted by Rob Harvey, Dimensional’s co-head of product specialists.

Introducing AVXC: A New Player on the EM Field

The movement among product issuers isn't static, with Avantis emerging as a pivotal figure. Responding to the surging investor demand, Avantis released the Avantis Emerging Markets ex-China Equity ETF, better known by its ticker AVXC, on March 21. Markedly, this migration assumes the mantle of a trending theme in the passive space—emerging-markets excluding China—as evidence mounts that investors are keen on making more granular wagers.

Jane Edmondson, head of thematic strategy at TMX VettaFi, adds a layer of nuance to the debate. She posits that, while there's inherent danger for an active manager in misjudging the China bet given its heft in the EM index, there also lies a "risk of ruin," but juxtaposes with a speculative "What if China rebounds?" adding to the gamble.

Key Indicators and Trends to Watch

As the global market's eyes remain set on imminent financial developments, Chile's central bank postures itself for a rate cut down to 6.5%, with the decisive survey from traders and investors as reference. Conversely, Poland is anticipated to anchor its interest rates at a steady 5.75%. South Korea, with its forthcoming CPI data, aims to cement the narrative of receding inflation rates.

The pulse of the manufacturing industry will also be measured through Manufacturing PMI data spanning territories such as Brazil, Mexico, Turkey and, notably, China's Caixin manufacturing PMI figures will be revealed, adding to the trove of indicators that multinational investors monitor meticulously.

Source: Bloomberg data through March 26, 2024

In closing, this report reflects on the agile adaptation and innovation in the sphere of emerging market investments. Actively managed ETFs are reaching new peaks of interest, as fund managers and investors alike navigate a more complex yet potentially rewarding financial landscape, with armed optimism—betting on not just the numbers, but on regions that stand at the precipice of economic breakthroughs.

Srinivasan Sivabalan lends his expertise in the assembly of this market digest.

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