‘Proactive management’ in emerging markets optimises alpha

Eaton Vance has highlighted the option of ‘proactive management’ available in emerging markets (EM), offering an alternative to active and passive management. 

In a research paper, the firm said the use of proactive management to optimise alpha generation from the sector.  

While passive was a popular choice for developed markets, the team said it worked less well in emerging markets as the opportunity set was limited and index concentration drove volatility. This reduced the capacity of passive strategies to capture the unique opportunities in emerging markets. 

“Benchmarks are not designed with the goal of generating strong performance, but to make them easy to replicate within passive portfolios. That is why indexes like the JPMorgan Global Bond Index – Emerging Markets (GBI-EM) comprise a relatively small number of larger, more liquid EM debt issues,” it said.  

“Consider the potentially negative impact:  

• The opportunity set is artificially limited. For example, the GBI-EM includes just 19 countries, and excludes 70 investable markets, with approximately $1 trillion worth of local-currency market capitalisation; 
• Index concentration drives volatility. In the GBI-EM, the top 10 countries account for 81% of its weight, as of December 31, 2020. This kind of concentration has been a major source of the Index’s historical volatility. 
• Investments are often suboptimal. Valuations of benchmark issues may be unattractive from an asset-price perspective, at any given time. But they are required holdings — by definition — for benchmark-based strategies; and 
• Developed-market risks are embedded.” 

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Instead a proactive approach to management could seek to capitalise on the broadest possible emerging market opportunity set. Eaton Vance said this offered benefits over traditional management as it allowed managers to be proactive and move beyond investment inputs and methods.