Emerging market managers tracking wrong benchmark
Standard & Poor's now regularly compiles an innovative investment measure. The "SPIVA" index suggests that most global and emerging market managers are actually tracking the wrong benchmark, and (even worse) are still underperforming key indices. (more) SMSF investors tell us that they value capital growth, and as many advisers are now witnessing, its time to rethink the levels of allocation to global equities. But we also know – from lessons well learned in the meltdown of returns from traditional global managers in 2000 to 2003 – that the traditional form of "benchmark aware" global equities allocations is severely flawed. It's ludicrous to allocate funds to countries which are economically sluggish, just because they form a part of a global equity index. To further compound the problems for Australian investors, it is increasingly clear that there are serious flaws in the methodology used to compile key indices such as the MSCI global index series.
As chart 1 shows, global growth is being spearheaded by the BRIC sector, which is growing three times as fast as the developed, "G7" nations.
Chart 1 : GDP Growth of BRICs Versus Developed Markets
As chart 2 shows, this strong growth from the BRIC sector is translating into a big change in the relative performance, and share of world economic output, between the BRIC sector and the G7. In the last 15 years, the BRIC sector's share of world economic output has almost doubled, while the G7 share of world economic output has dropped by 20%.
Chart 2 : Share of World Economic Output
So why then are global active managers maintaining their out of date allocation levels to the relatively sluggish G7 nations? Just because manager's have big investments in the infrastructure and personnel required for traditional "developed nation" investing, shouldn't be a rationale for them to overlook the new reality of emerging market and BRIC sector growth. In fact, even those managers that allocate to the emerging markets, are doing so based on a flawed methodology.
As Chart 3 shows, the BRIC sector has a 500% greater contribution to world GDP than the country grouping of Korea, Taiwan and South Africa – and yet in the key EM index, the MSCI Emerging Market Index, the latter countries have a 20% higher weighting than the BRIC sector!
Chart 3 : Economic Footprint Versus Stock Allocation
As a result of these anomalies in the compilation of mainstream indices, its important when using index based products, that a clear understanding of the methodology used in that compilation needs to be had.
As chart 4 shows, there are a range of newer style indices that are available for global investment.
Chart 4 : Market Share of BRIC Indices Among BRIC Index Products
The key analytic of interest to SMSF advisers and investors is chart 5 which shows that active EM managers have underperformed the S&P EM "ISCI" index over a three and five year period. You can see more of this approach at the S&P "SPIVA" website, www.spiva.standardandpoors.com.
Chart 5 : Performance of Actively Managed Emerging Market Funds
Whether or not you are considering making an allocation to emerging markets, or to the BRIC sector, its clear that the rationale for index investing is very strong... and also, that its vital to allocate to an accurate index.
Tony Rumble, PhD.
