Emerging markets: You don’t get what you pay for

June 14, 2011

Roughly $2 billion a month has been flowing into emerging market mutual funds recently, an amount that makes it one of the more popular destinations for nervous U.S. investors in recent weeks.

Underlying those investments are a couple of core beliefs:  (1) That China, India and other growing powerhouses will continue to deliver big returns to investors; and (2) That smart portfolio managers can suss out the best stocks in this space, justifying the higher costs of active management.

So far this year, passive indexed emerging market funds have actually seen outflows of $2.12 billion in assets while actively managed emerging market funds have pulled in $7.02 billion in new money, according to Lipper, the research unit of Thomson Reuters that’s been watching those fund flows.

Maybe that’s because the so-called “smart money”  is already selling its emerging market shares to the follow-the-bubble crowd. But it also reveals an investor preference for those actively managed emerging market funds. Just today, “passive” powerhouse Vanguard Group has launched an actively managed emerging markets fund, the Vanguard Emerging Markets Select Stock Fund, in response to demand from some investors for that kind of product.  (The new fund won’t be fully open for investing for two more weeks. Until then it’s in its subscription period — accepting investments directly from individual investors and accumulating enough money to build its initial investment portfolio.)

“A manager on the ground might have some advantage there,” says Chicago money manager Andrew Feldman, speaking specifically of emerging market funds specializing in small cap stocks.

But is there a management advantage? At my request, Lipper looked at the returns of actively and passively managed emerging market funds and found that the indexes are handily beating the managers. The average annual return for three years running in indexed emerging market funds is 1.87 percent, says Jeff Tjornehoj, head of Lipper Americas Research.  For actively managed funds in the same space? An average annual loss of 0.95 percent.

What’s the takeaway? Don’t be so sure that man or woman on the ground can justify the extra expenses, which can run a full percentage point or more above those of an indexed fund.  And listen to Vanguard’s chief economist, Joe Davis, who cautioned investors against “chasing performance” in a statement released when this new fund was announced. There’s the very real possibility that, while there still may be a substantial amount of punch left, you are late arriving to this party.

2 comments

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Where I live if you bought into the market you would be buying the owner of the company a new car.

Posted by Sonnyjc9 | Report as abusive

Investing personally into emerging markets can get you a hardcore return on investment. Some white guy here now has his own chain of restaraunts which are as known as mcdonalds, others have used their knowledge of the west to set up in needed fields but one the locals aren’t experienced with. You can come to the emerging world and become a king if you have the mind and money.

Posted by djlowballer | Report as abusive