Monday, December 7, 2009

About Growing Up - Tigers and Frontiers enters the next stage of its development

Introduction: performance of Model Portfolios Sep - Nov 2009

We followed our four model portfolios, based on strategic choices extracted from the Morningstar database, for 3 months now. Graph 1 shows our cumulative performance vis-a-vis a set of relevant major market indices.

Graph 1; Cumulative Performance Model Portfolios Sep-Nov 2009

A few things catch the eye:
  1. The MSCI Emerging Markets index was the winner during this period with a total performance of 11.94 percent, i.e. approximately 4 percent per month. None of the model portfolios or other benchmarks did get close to that impressive performance.
  2. The Frontier Markets didn't do well. See how their performance collapsed during the month of November. However, our Next-11 strategy - based on Goldman Sachs's Next-11 concept - outperformed the Frontier index in a stunning way: +4.69 percent versus -5.60% during this 3 months period. That is an outperformance of about 3.4 percent per month!
  3. The MORFAV portfolio containing favorite stocks of some of the best Emerging Markets funds selected based on their top-10 holdings scored an overall cumulative performance of 4.81 percent, approximately equal to the 5.02 percent of the MSCI World benchmark. However, the latter had a lower market risk and volatility.
  4. The EMWIN portfolio with major stocks from Emerging Markets Winner countries (based on the situation as of End-of-August 2009) didn't do very well with a cumulative performance of +2.78 percent.
  5. The EMLOS portfolio with major stocks from Emerging Markets Loser countries (based on the situation as of End-of-August 2009) had a good start in September 2009 but lacked thereafter. Its total cumulative performance over the 3-months period Sep-Nov 2009 was -0.86 percent.
Why did 3 out of 4 model portfolios underperform?
Overall, 3 out of 4 portfolios had no chance against their benchmark, the MSCI Emerging Markets Index. Is this logical, or was our analysis period simply too short? We believe that it was logical, for a couple of reasons:
  • First of all, our model portfolios weren't really very well diversified. All of them contained 10-15 holdings. True, top-level Emerging Markets asset managers would create portfolios with at least 25-50 holdings. Some of the quantitative managers run portfolios with more than 100 holdings. Work by Markowitz, Solnik and others has indicated that the main positive effects of diversification (reduction of sensitivity to individual stocks and/or specific valuation factors) can be achieved only with portfolios of at least 20-25 holdings. So that was explanatory risk factor number 1.
  • Second, there was a size factor. Surprisingly enough, a large part of the bad performance in Emerging Markets - be it during the whole Global Crisis period from 2007 to March 2009 or later in individual bad months - was caused by panicky Western (institutional) investors. They still use the old concept, in which the most risky holdings are sold first in times of trouble. Nothing wrong with that, but they still define Emerging Markets as the most risky parts of the world. It remains to be seen if that is true, when looking at structural growth prospects in the future. With Western investors normally holding portfolios with stocks of a larger average market capitalization, we see that this translates into portfolios that perform less well in bad periods. Within the MSCI Emerging Markets, the bulk of good performance in Emerging Markets was located in the Mid- and Small-Market-Cap segments.
  • Third: the largest holdings in portfolios of Morningstar favorites are normally well-documented stocks that everyone active in Emerging Markets knows about. It is the more 'neglected' smaller stocks where the bulk of value is located. I.e. the small-cap effect mentioned in the previous explanation and the 'neglected' firm effect mentioned here go hand in hand. 
All of this translates into the conclusion that (smaller) private clients should consider following an index strategy in Emerging Markets. Once they are bigger, they can construct their own portfolios and/or incorporate funds. Diversification and a true Best-of-Breed label are in that case important. Our little research experiment indicates that it is not so easy to beat the MSCI Emerging Markets index.

In the Frontier Markets inefficiencies play a larger role, as a result of which our relative performance was far better. True, quite a bit of the Next-11 portfolios performance was realized with stocks that are technically not part of the Frontier Index, but when analyzing the performance of individual Frontier Funds we see indeed that relative performance is better in this market segment. But once again: don't underestimate the complexities of the New Markets.

Tigers and Frontiers: The Next Phase
We are pleased to announce that Tigers and Frontiers will enter its next phase. Via clients and prospects, members of our firm's social network LMG World TV and interested readers we got feedback that the interest in commentaries and analyses about investments in Emerging Markets is growing. See graph 2 for a print screen of LMG World TV. Feel free to click on the link here to join.

Graph 2: LMG World TV, our firm's social network

People do realize that these markets are here to stay. And they do also realize what we showed with our simple experiment: investing in Emerging Markets is (still) risky and complicated. Non-diversified, active portfolios carry an embedded risk that performance could be very disappointing. In other words: specialist advice is needed. Not only do we of course help you with this in LMG, we also joined efforts with two important online Emerging Markets specialists:
  • EmergInvest  
    • EmergInvest is a US-based provider of Emerging Markets stocks information. Daily quotes for a large number of stocks in both Emerging and Frontier markets. You can follow your portfolios here, create watchlists and EmergInvest has teamed up with a group of interesting partners - with us being one of them - that provide you with market news. EmergInvest did also team up with major brokerage firms, which enables you to translate things quickly into real action.  
  • Emerging Voice
    • Emerging Voice is like an online newspaper focusing on Emerging Markets. Lots of daily news at the global, regional, country, sector and firm level. Emerging Voice has teamed up with partners as well, with us again being one of them. We believe that investors will be well prepared for Emerging and Frontier Market action by combining the news from Emerging Voice with the detailed market data of EmergInvest and our own analyses at Tigers and Frontiers.
 Graph 3 and Graph 4 show a print screen of the webpages of our new partners.

Graph 3: Print screen of the website of our partner EmergInvest

Graph 4: Print screen of the website of our partner Emerging Voice

New Format
In this triangle with the new partners, and based on the needs of our social network LMG World TV, we felt that Tigers and Frontiers should enter this new phase with a new format. More diversified, more up-to-date, more topics.

In the new format we will write shorter and longer pieces on Emerging and Frontier Markets that can be classified in one (or more) of the 10 following categories:
  • General / Global
  • Regions
  • Countries
  • Sectors
  • Firms
  • People
  • Funds
  • News
  • Science
  • Literature 
Contributed pieces will either be written by ourselves or they will be linked to or from other websites, with LMG finding them interesting enough post them here.

We are pleased with this new development. We hope that you will enjoy it too! 

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