“To win in emerging markets, avoid the passive investing rush,” proclaimed the headline of a July 2017 Bloomberg article. That sentiment happens to be one of the greatest, and hardest to kill, canards in the legion of canards espoused by proponents of active management. But let’s give it a try.
A highlight of the article was the claim (citing Morningstar data) that stock pickers with funds domiciled in Europe have beaten passive funds 60% of the time in emerging markets over the last five years.
The article continues: “Picking stocks on the Standard & Poor’s 500 is an entirely different animal from navigating more than two dozen emerging equity markets in countries where data can be scarce and political upheaval often takes investors unaware. Some emerging-market stocks don’t even trade every day.”
The article is just another in a long series based on the idea that, while U.S. markets might be too efficient for active managers to persistently outperform, emerging markets are much less efficient. With that in mind, let’s see if this assertion is correct.
Testing A Claim
One simple way to test the claim is to examine the performance rankings of two of the leading providers of passively managed emerging markets funds—index funds from Vanguard and structured portfolios from Dimensional Fund Advisors (DFA). None of their funds engage in any individual stock selection or market timing, the hallmarks of active management.
The table below shows the performance ranking provided by Morningstar for the 15-year period ending July 13, 2017. (In the interest of full disclosure, my firm, Buckingham Strategic Wealth, recommends DFA funds in constructing client portfolios.)
Before reviewing the results, it’s important to understand that the data from Morningstar has a very large survivorship bias—it considers only funds that have survived the full period. This contrasts with data provided through the S&P Dow Jones Indices Versus Active (SPIVA) scorecards, which is free of survivorship bias. Its rankings consider all funds that began the period, whether they survived or not.