Important legal information

The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.

The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.

Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.

Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.

This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.

I Disagree
Emerging markets: the value of strategic allocation

Emerging markets: the value of strategic allocation

12-11-2015 | Research

The added value of allocating to emerging markets (EM) has always been a topic of discussion among equity investors, especially when there was a large difference in performance with developed markets (DM). After a period of market decline, investors sometimes consider to lower the weight of emerging markets in their portfolio. What are the lessons that history can teach us?

  • Weili  Zhou
    Weili
    Zhou
    CFA, Director, Researcher

Speed read

  • Allocating to emerging stocks increases the Sharpe ratio of an equity/bond portfolio
  • Allocating to factors in emerging equity markets is even better
  • Dynamic allocation does not appear to add value: we recommend a strategic allocation

In investing it is always important to take the long view. In a recent paper with data over the period from January 1988 to September 2015, we have taken a fresh look at the strategic allocation to emerging equities.

We started by investigating the long-term return characteristics of developed markets equities as measured by the MSCI World index and emerging markets equities as measured by the MSCI Emerging Markets index. The excess returns over cash of emerging markets have been roughly 75% higher than in developed markets. The volatility is 50% higher, which, when combined, results in a higher Sharpe ratio.

We also found that allocating to emerging markets increases the risk-adjusted performance of a traditional developed markets equity/bond portfolio. The portfolio volatility increases when you add emerging equity markets. But returns are even higher, from 3.7% excess return when you do not allocate to emerging markets to 4.6% excess return when you allocate 20%, resulting in a significantly higher Sharpe ratio (up from 0.38 to 0.43).

Given the potential for extra returns investors might be tempted to dynamically allocate to emerging and developed market equities. We tested the predictive power of many factors and find little to no predictive power. Only for price momentum did we find some evidence in predicting whether emerging markets will out- or underperform developed markets. If momentum works, you could argue that this implies that the weights of emerging and developed market equities in portfolio should not be rebalanced too often.

Stay informed on Quant investing with monthly mail updates
Stay informed on Quant investing with monthly mail updates
Subscribe

Factor premiums in emerging markets

Investors can not only allocate to the emerging market equity premium, but also to other premiums within the equity market. We constructed a value and momentum index by each month considering the equally-weighted returns of the 33% most attractive stocks on respectively the earnings-to-price ratio and its 12-1 month momentum, assuming a 6-month holding period.

An emerging markets multi-factor quant portfolio consisting of a 50/50% allocation to the momentum and value factor premiums exhibits a significantly better risk-adjusted performance than the passive market portfolio. Specifically, the total return is over 6% higher than the market portfolio with similar volatility. The Sharpe ratio is 0.57 against 0.30 for the market index.

Emerging equity markets have disappointed in recent years. Yet, our empirical research shows that allocating part of an investor’s portfolio to emerging markets equity adds value and even more when the portfolio has exposures to the value and momentum factors. We therefore recommend investors to strategically allocate part of their portfolio to factor premiums in emerging equity markets.