Stock Pickers Left Out of $50 Billion Emerging-Markets Rush

A glance under the hood of this year’s emerging-market rally signals many investors aren’t yet convinced an economic rebound in developing countries has taken hold.

While a net $50 billion rushed into developing-country stock and bond funds in 2016, only 20 percent went into shares and all of that to lower-cost passive exchange-traded funds tracking indexes. Active money-managers of equity portfolios suffered outflows of almost $11 billion this year through Sept. 23, according to data company EPFR Global. These stock-pickers charge more and typically only attract clients once they’re convinced an investment case has legs.

By favoring bonds and passive strategies, the flows signal that although major emerging economies such as Brazil and Russia will probably pull out of recession next year, investors aren’t yet ready to bet that growth will be fast enough to drive a rebound in corporate profits. Projected earnings per share for companies in the MSCI Emerging Markets Index are still 18 percent below their five-year average, even after rising 2.4 percent in 2016.

“Investors see opportunities, but they have reservations about the longer-term prospects for emerging-market equities,” said Maarten-Jan Bakkum, a senior strategist who recommends buying Indian and Indonesian stocks at money manager NN Investment Partners in The Hague, which has about $219 billion in assets. “To invest in an actively managed fund with a higher management fee, conviction also about the longer term must be higher.”

Beating Peers

Emerging-market stocks have rallied 15 percent this year, on course to beat peers in industrialized countries for the first time since 2012. When shares started climbing this year, many money managers were still holding less than recommended by benchmarks. The quickest way to reverse underweight positions is to buy into an ETF, said Thomas de Saint-Seine, who oversees about $4.2 billion in stocks at RAM Active Investments SA in Geneva.

"A lot of institutional investors were underweight that market, so they’re catching up," he said.

Growth in emerging economies will probably accelerate to a four-year high of 4.9 percent on average in 2017, according to estimates compiled by Bloomberg, an outlook supporting the rally in stocks. That’s short of 7.8 percent in 2010 and Goldman Sachs Group Inc. said this month it doesn’t expect a return to those "halcyon days" any time soon with Chinese expansion at a quarter-century low.

Investors can still find shelter in emerging stocks from sub-2 percent developed country growth and slower European corporate profits. While the MSCI Emerging Markets Index retreated 0.9 percent on Friday, analysts project an almost 10 percent gain in the next 12 months, bringing it above 1,000 for the first time since June 2015, data compiled by Bloomberg show. 

That advance may start to benefit active managers more than ETFs. MSCI Inc. said on Wednesday some countries and industries are beginning to perform better than others. When there’s disparity of returns within an index, active managers have an opportunity to outperform because they can discard stocks they expect will lag whereas ETFs must track the entire benchmark.

RAM’s de Saint-Seine turned away potential clients last month from the $2.9 billion Systematic Emerging Markets Equities fund he manages after it attracted $400 million in net inflows this year. He allocates more than 50 percent of assets to small and medium-sized companies which are less easy to trade than larger stocks and expanding the fund threatened to stoke volatility.

Stock Pickers

"While a pension fund may use an ETF from a tactical standpoint, they might start to look at investing larger sums, maybe through segregating mandates and actively managed funds as well," said Antoine Lesne, an exchange-traded fund strategist for Europe the Middle East and Africa at State Street Global Advisors in Brussels. “The largest flows may be still waiting to be triggered."

For now, passive funds are the most popular way to access emerging stocks that are on course for their biggest quarterly return since 2012. Investments in developing-country ETFs listed in the U.S. that buy equities and bonds, have topped $21 billion over 17 weeks, according to data compiled by Bloomberg.

"The growth outlook is still too meager to really believe that we will have some great years ahead," said Bakkum at NN Investment Partners. "But by year-end I think emerging-market equities will be higher than current levels," and active funds will start joining the party, he said.