Passive investing strategies continue to attract big money. But think carefully before choosing to track a benchmark in emerging markets (EM). Active managers offer several clear benefits for equity investors in the developing world.

The flood of money moving into passive strategies shows no sign of letting up. In the first four months of 2017, investors pumped $248.8 billion into passive equity strategies globally while redeeming $58.0 billion from active equity strategies. Low-cost index tracking funds are alluring to investors who have lost faith in active strategies that aim to outperform the market. While some active managers have outperformed consistently, many investors feel that it’s just too difficult to identify them in advance.

FUZZY LOGIC

But does this logic hold true in all parts of the global equity market? Not really. In EM, active equity managers have performed especially well. Yet EM funds haven’t been immune to the trend toward passive.

Over the past year, passive global EM equity funds captured $43.0 billion globally, outpacing the $8.7 billion of inflows into active funds. EM is one of the few equity categories that have recorded positive flows to active. Still, passive strategies now account for 32% of total EM equity assets globally, according to Morningstar fund data.

CONSISTENT OUTPERFORMANCE

The concerns about active managers don’t really apply to EM. Most active EM managers have outperformed the index consistently, even after fees. In fact, 70% of active managers in emerging equities have beaten the benchmark over the five-year period ended March 31, 2017, while 66% have outperformed over 10 years, net of fees. On a rolling five-year basis, the percent of active managers outperforming the EM index has never fallen below 50% (Display).



There are several reasons that explain why active managers have a clear advantage in EM, in our view.