Quantitative stock selection models work as well in emerging markets (EM) as they do in developed ones (DM). However, their implementation in the former requires additional expertise. Arlette van Ditshuizen and Tim Dröge from our quant equities team explain what makes quant investing in EM slightly more complex and how we address this challenge.
Tim Dröge: “Well, there are, in fact, many differences. Trading is different, regulation and corporate governance standards are different, capital gains taxes can be very different and currency conversion also needs to be handled differently. And that’s to name just a few examples.”
Arlette van Ditshuizen: “On the trading front, for example, there tends to be less liquidity in EM than in DM, while trading costs tend to be higher, which obviously has an impact on returns. But this is by no means the only difference. Another important aspect has to do with block trading. Unlike in the US or Japan, where there is almost no block trading, stocks in many EM countries are frequently traded in such significantly large numbers.”
“This is especially the case in countries such as Brazil, Mexico, Chile or Colombia, where large institutional investors like to trade blocks and therefore tend to be liquidity seekers. As investors, we like to provide that liquidity. This helps us bring down trading costs. For that purpose, Robeco has two EM trading desks – one in Hong Kong, for all Asian shares, and one in Boston, for shares from Latin American countries.”
We carry out additional screening in EM to ensure that the quality of the data used as input for our models is sufficient
Dröge: “Yes, governance is clearly an area in which EM-listed companies are not always on a par with their DM counterparts. Therefore, we carry out additional screening in EM to ensure that the quality of the data used as input for our models is sufficient and to identify any issues the model cannot detect. This is especially true for Chinese A-shares. Within Robeco’s quant equities team, portfolio manager Yaowei Xu is responsible for this extra step for two of our dedicated A-shares quantitative strategies: Active Quant Chinese A-shares, which is aimed at delivering stable outperformance, and Conservative China A-shares, which is aimed at delivering lower volatility.”
“These issues can range from simple ‘back-door listings’1 to potential fraud. For example, in recent years, a number of companies have seen their share prices plummet when informed market participants raised red flags after studying suspicious trading patterns and accounting reports.”
Dröge: “Yes, taxes are another very important issue. Broadly speaking, there are two main types of tax: exchange tax and capital gains tax. In India, for example, there is a 10% capital gains tax, while in South Africa they have a stamp duty. But you can avoid these by buying alternative instruments such as ADRs (American depository receipts) or GDRs (global depository receipts) instead of locally listed stocks.”
“What’s more, ADRs and GDRs offer many other advantages compared to locally listed stocks. Being listed in US dollars, in New York or London, they are generally easier to access and trade for foreign investors than locally listed stocks and don’t involve high currency conversion costs. They also usually involve lower custody and broker costs and are not subject to potential restrictions in terms of capital controls. All of these elements explain why for approximately 10% of our quant EM portfolios, we prefer to buy ADRs and GDRs instead of the local shares you’ll find in the index. In rare cases ADRs can also have disadvantages, like unclaimable dividend taxes or premiums. In such cases we aim to avoid the premium and buy the local shares instead.”
Van Ditshuizen: “Yes, but bear in mind that corporate actions such as mergers, spin-offs and delistings are generally more complicated to handle in EM anyway. The same goes for index additions and deletions, because a significant amount of money invested in EM is being managed relatively passively – either following index-based strategies or using a simple buy-and-hold approach. Compared to DM, the lack of arbitrageurs exacerbates the price moves triggered by addition and deletion announcements in EM.”
“To address this, Robeco’s teams follow a process that predicts whether a stock will be removed from the EM index. If that is the case, we aim to avoid buying it for our Conservative, Enhanced Index and Active Quant portfolios in the period between one month before the announcement date and the actual day of rebalancing. Additions to the MSCI EM Index are already included in the universe by including MSCI EM IMI small caps (and FTSE / S&P IFCI off-BM stocks) in the eligible universe. If these stocks are not yet in the MSCI EM Index, top-ranked companies can already be bought outside of the index and our strategies can therefore profit from MSCI additions. If countries are promoted from frontier to emerging market, we prefer to include the upgraded country as an off-benchmark opportunity six months before the effective date to benefit from expected upward market movements.”
Dröge: “Furthermore, with our Enhanced Indexing strategies, if a MSCI EM index deletion is ranked at the bottom according to our stock selection model, we aim to sell it before it is removed from the index.”
Dröge: “Currency conversion costs are indeed another difference. It is relatively straightforward to trade DM currencies like the euro, the US dollar and the British pound. These currencies are being traded efficiently by our FX trading desk. On the other hand, currencies like the Korean won, Indonesian rupiah, Brazilian real or Thai baht are not freely tradeable or may carry trading restrictions, so we need to outsource this to our custodian. To make sure conversion costs remain low, we have negotiated low spreads with our custodian and we ask them to net equity buy and sell transactions as much as possible, to minimize currency conversions.”
This article was initially published in our Quant Quarterly magazine.
1 A ‘back-door listing’ usually occurs when a privately held company purchases a publicly traded one, thereby avoiding the public offering process and securing an automatic stock exchange listing
The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.
Please read this information carefully.
This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.
2. Important risk disclosures
Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:
3. Local legal and sales restrictions
The information contained in the Website is being provided for information purposes.
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. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.
4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.
5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.
6. Third party websites
Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage.
7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.
8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.
10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong.