Slightly more than half of active emerging markets equity managers underperformed the MSCI Emerging Markets Index (gross of fees) in 2020—the fourth time the median manager has underperformed the benchmark out of the last five years. The median manager trailed the index by 30 basis points (bps). After applying a fee proxy of 90 bps, 53% of managers underperformed. However, 15% of managers outperformed the index by more than 1,000 bps, representing significant value-add.
Country bets can have a large impact on relative performance. The median manager held a more than 750 bp underweight to China at the start of 2020, which was likely a headwind to manager returns since China outperformed the broader index by a whopping 1,119 bps in USD terms. However, managers implementing out-of-benchmark bets to the United States likely benefited as US equities bested the MSCI Emerging Markets Index.
Managers’ sector allocations also can differ substantially from the index. The median manager held moderate overweight position to the top three performing sectors in 2020, providing a tailwind for manager performance relative to the benchmark; however, managers were heavily underweight other top-performing sectors—communication services and materials—creating a net drag on performance.
Active managers tend to make off-benchmark bets and hold some cash, so three factors can create a better environment for active management: outperformance of small-cap stocks, outperformance of stocks in frontier markets, and outperformance of cash over the index. Just one of these factors were present in 2020—the MSCI Emerging Markets Small Cap Index topped the MSCI Emerging Markets Index by 98 bps.
Persistence in manager performance is rare, and movement among performance quintiles is fairly common. Of the top-performing quintile of emerging markets equity managers in the 2011–15 period, 15% placed in the bottom quintile over the subsequent five-year period (2016–20). Similarly, 15% of bottom-performing managers in the initial five-year period were in the top quintile in the most recent five-year period.