Core and diversified: generating alpha across EM cycles

An already challenging landscape for DC plans has been exacerbated by COVID-related market volatility. This has heightened the need to consider how to capture alpha across market cycles.

Nov 5, 2020

10 minutes

An already challenging landscape for DC plans has been exacerbated by COVID-related market volatility. This has heightened the need to consider how to capture alpha across market cycles.

The fast view

  • We believe that a core and diversified approach to emerging market equity investing is best placed to weather market cycles and meet the fiduciary responsibilities for defined contribution (DC) plans.
  • Delivering alpha across market cycles, in our view, requires being style agnostic with balanced exposure to sectors alongside high conviction stock selection underpinned by in-depth fundamental research.
  • We have embedded ESG analysis into our investment process to mitigate such risks, which is particularly key in emerging market investing. We believe there are also opportunities for targeted engagement to drive share price and corporate performance.
  • A disciplined bottom-up framework can maximize the stock-picking potential inherent in emerging markets and aim to deliver alpha over the long term.

Given the current fiduciary landscape, investment committees for DC plans are selecting options with less risky approaches than seen in the past, as several lawsuits have put fiduciary responsibilities into the limelight. One of which is selecting prudent investments that meet plan objectives, which accounts for the change in preference for selected funds.

Figure 1: Lower tracking error than emerging market equity peers

Source: eVestment Global Emerging Mkts All Cap Core Equity, USD, calculated relative to manager preferred benchmark, as at June 30, 2020.

We believe the best way to generate alpha across market cycles is through a core and diversified portfolio of 70-90 stocks with reasonable stock, sector, and country constraints. This has led to lower tracking error when compared to active emerging market equity peers (Figure 1).

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Specific risks:
International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from social, economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Investments in smaller companies typically exhibit higher volatility.
General risks:
The value of investments, and any income generated from them, can fall as well as rise. Where charges are taken from capital, this may constrain future growth. Past performance is not a reliable indicator of future results. If any currency differs from the investor's home currency, returns may increase or decrease as a result of currency fluctuations. Investment objectives and performance targets are subject to change and may not necessarily be achieved, losses may be made.

 

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