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Emerging markets

Assets bounce back despite some shocks around globe

Equity, bond markets see strong inflows for year

Stephen Clark
Dimensional Fund Advisors' Stephen Clark: 'The markets do a pretty good job of pricing in (geopolitical risk). And if they don't, they adjust pretty quickly.'

Updated with correction

Assets under management in emerging markets equities and debt rebounded in 2016 as managers in both asset classes more than withstood geopolitical headwinds from Brexit and the U.S. presidential election.

“The markets do a pretty good job of pricing in” geopolitical risk, said Stephen Clark, head of global institutional services at Dimensional Fund Advisors, Austin, Texas, and president of Dimensional International. “And if they don't, they adjust pretty quickly.”

Emerging markets equity assets managed for U.S. institutional tax-exempt clients totaled $331.7 billion as of Dec. 31, according to Pensions & Investments' annual survey. That's up 9.6% from Dec. 31, 2015. Emerging markets debt assets under management totaled $84.9 billion, up 6.6%.

Those gains reversed the results of 2015, when AUM in emerging markets equity dipped 0.6% and emerging markets debt assets were down 6.7%, according to P&I data.

The 2016 increase was concentrated among the top 25 managers in both emerging markets categories. A total of $270.2 billion in 2016 was managed by the top 25 managers of emerging market equity assets, up 30% from 2015, and a combined $80 billion was managed in emerging markets debt assets, a 59% increase.

Dimensional Fund Advisors continued its pole position in emerging markets equities in 2016, with $48.9 billion under management as of Dec. 31. The figure is 21% above the $40.5 billion Dimensional reported in 2015.

In emerging markets debt, Nuveen — which was rebranded from TIAA Global Asset Management in 2016 — led the list with $9.7 billion in assets, though down about 1% from the combined total of the previous year.

Sources said asset gains of managers were driven more by strong performance than inflows. The Morgan Stanley (MS) Capital International Emerging Markets index was up 11.2%, while the J.P. Morgan Emerging Markets Bond Global Diversified index returned 9.9%.

“If you look at the representative index, it looks like the rise in assets is in line with that or a little below,” said Iain Douglas, senior investment consultant and head of emerging markets equity manager research, Willis Towers Watson PLC, New York. “It looks like asset inflows have been steady but that the market is going up.”

Added Rich Nuzum, senior partner and business leader for growth markets, Mercer Investments, New York, “There's a story as to why there's increased demand” in emerging markets equities and debt. “The changes from 2015 to 2016 were mainly driven by return.

Mr. Nuzum said several factors point to future asset inflows into emerging markets and more RFPs for emerging markets managers.

“I think, back a year to 18 months ago, there was concern that we'd see the end of conservative monetary policy and central bank activity that would hurt emerging markets, particularly in debt denominated in U.S. dollars,” said Mr. Nuzum. “The concern was that if interest rates rose, companies would have a tougher time. The other uncertainty was Brexit, the Trump election and the rise of anti-globalization, and how that would hurt trade and the global economy. But the worst has not come to pass. It's almost a year since the Brexit vote and just over 100 days for Trump; we haven't seen any rollback in globalization or free trade. And the French vote didn't go down the path of leaving the EU.”

Mr. Nuzum added that oil and gas prices have stayed down. “That does have a negative effect on some emerging markets countries that depend on their energy production,” he said, “but a large portion of emerging markets and frontier markets are commodity importers, and the lower energy costs will help their balance sheets.”

Outflows become inflows

Gaurav Mallik, senior managing director, global head of equity portfolio strategies at State Street Global Advisors, Boston, said outflows reported by the firm in 2011, 2013 and 2015 became inflows in 2016. “We saw assets leave the asset class because of global concerns,” Mr. Mallik said. “In 2016, we saw a little stimulus in China. And when I look at the entire book of business, what I saw was, despite all the good things in the U.S., investors were looking at the strong U.S. dollar as a reason” for increasing their emerging markets allocation. SSGA ranked second in emerging markets equity AUM in 2016, at $25.3 billion, up 10.5% from 2015, when it also came in second.

Mr. Douglas of Willis Towers Watson said he was most surprised by the concentration of assets among the top 25 managers. “There's a natural bias to focus on brand names that have long track records,” Mr. Douglas said. “But to us, that's concerning. If you have large assets to invest in emerging markets equities, it makes it more difficult to find where to put that money to work.”

Such a concentration could lead to capacity issues “that could eventually impact performance,” Mr. Douglas said. “If you're not among those top 25 managers, there will be fewer stocks for you to choose from, even if you're the best manager in the world. The MSCI index is concentrated with stocks in the top of the market, so most managers are forced to invest in those. There's a limited amount of equities in emerging markets beyond those.”

However, Mr. Nuzum said that, apart from certain emerging markets strategies that are closed, “on the asset-class level, there are no issues with capacity in emerging markets.”

“If a sovereign wealth fund wants to make a move, because of their size capacity might be an issue,” Mr. Nuzum said. “But for other kinds of funds, there's a lot of opportunity. Issuance is rising, and governments and banks have stepped back in those markets, so now companies are financing in the capital markets, which raises capacity. And as more emerging markets privatize, that raises market cap on both equities and debt, and that provides more capacity. If our clients are big, we have to talk to them about capacity, but for the vast majority of investors, capacity is not an issue.”

The concentration of assets in the top 25 is the result of investors that “look for experienced management,” said John Panagakis, executive vice president, head of international advisory services, Nuveen, in New York. Along with its first-place ranking in emerging markets debt assets in 2016, the firm was seventh in emerging markets equities at $10.4 billion, up 9.4% from its ninth-place finish in 2015.

“We feel emerging markets equity and emerging markets debt should be part of anyone's portfolio,” Mr. Panagakis said. “But with all the hype of the growing middle class in emerging markets, we're seeing a lot more interest. The question now is if there's room left to run. … People are paying attention (to emerging markets) at the corporate level, the sovereign level and the issuer level.”

SSGA's Mr. Mallik said he didn't see any restraints in emerging markets capacity. “We're more stock-focused than country-focused,” he said. “(Capacity) is not an issue when you have a fairly liquid market. Most emerging markets already have their own stock market, and many are active in issuance. We don't think there are any restraints.”

Not surprised

Thierry Adent, senior investment consultant, fixed-income manager research, at Willis Towers Watson, said he wasn't surprised by the concentration of emerging market debt assets among the top 25. “But there's a lot of overlap with what they offer,” Mr. Adent said.

“It's hard to find managers there that can outperform,” he continued. “We're trying to find more nichey managers that are smaller and can outperform the larger firms. ... If you look at the underlying assets, concentration impacts the managers' ability to add value. Most of them are active. There's value available by indexing a universe. In the active space, it's harder to add that value.”

But Mercer's Mr. Nuzum sees passive or quantitative strategies leading the way in emerging markets equity. “And if that's where they're (the top 25) seeing their growth, it's growing faster than the rest of the group. Our view is that the consensus is emerging markets is going active, so to see the rise in assets with passive managers is interesting.”

Said Nuveen's Mr. Panagakis, “I think most of the passive growth is fee-driven. The emphasis seems to be on cost and not value. Now, should you pay 300 basis points for emerging markets equity? Absolutely not. But if you can get the benefits of alpha with less cost, that's attractive to investors. We do some indexing on the equity side, but we're more about active management in emerging markets.”

Dimensional's Mr. Clark said his firm was not passive but instead was “more systematic, rules-based. We're not replicating the market. When you talk to people in the market, they see it as inefficient, and so you'd need an active manager. But our research has shown that's not the case.”

This article originally appeared in the May 29, 2017 print issue as, "Assets bounce back despite some shocks around globe".