To state the obvious, emerging markets equities are risky. Investors are exposed to extreme levels of unpredictability due to elevated levels of political, currency and liquidity risk.
However, there is another, lesser-known characteristic of this asset class that further reinforces this notion of risk—emerging markets routinely experience large drawdowns. And these drawdowns should have emerging markets investors thinking about strategies that offer downside protection.
In fact, in every calendar year since 2001, the MSCI Emerging Markets Index has posted a market drop exceeding 10%, with nearly half of these drawdowns exceeding 20%. Perhaps most surprising, these drawdowns can happen even during particularly bullish calendar years. For example, 2004, 2006 and 2009 all experienced calendar-year index returns in excess of 25%, but they also experienced maximum drawdowns in excess of 20%.
Return and Maximum Drawdown for the MSCI Emerging Markets Index, By Calendar Year, 2001-2017
Source: MSCI, Parametric, as of 06/30/2017
For illustration purposes only; not a recommendation to buy or sell any security. It is not possible to invest directly in an index.
If a 20% drop indicates a bear market, and a 20% gain indicates a bull market, this means emerging markets investors experienced a bear market on their way to booking a bull market return for each of these three years. Now that’s volatility!
Enough is Enough: Why We Cap Country Exposure in Our Emerging Markets Strategies
Should you cap your exposure to China? We think so. We argue that the growing concentrations in many emerging markets indexes do not make a great deal of sense. Learn more about why we believe in maintaining country weight caps.
Evolution of Country Rebalancing Triggers for the Emerging Markets
Parametric periodically performs longer-term research projects into key aspects of its emerging markets strategy, typically centered on the country weighting scheme, the rebalancing triggers, and the sector weighting algorithm.
Potential Parametric Solution
Our Emerging Markets Strategy includes large-, mid-, and small-cap stocks in over 50 developing countries. The strategy invests across both emerging and frontier markets using a top-down, three-part process designed to eliminate country and sector concentrations. We apply a disciplined, unemotional trading approach to build and maintain the strategy’s investment exposures.
Tim Atwill, PhD, CFA – Head of Investment Strategy
Mr. Atwill leads the Investment Strategy team at Parametric, which is responsible for all aspects of Parametric’s investment strategies. In addition, he holds investment responsibilities for Parametric’s emerging market and international equity strategies, as well as shared responsibility for the firm’s commodity strategy.
“MSCI” and MSCI Index names are service marks of MSCI Inc. (“MSCI”) or its affiliates. MSCI makes no representation regarding the content of this material. Please refer to the MSCI website for additional information about the MSCI Emerging Markets Index. Global market investing, (including developed, emerging and frontier markets) carries additional risks and/or costs including but not limited to: political, economic, financial market, currency exchange, liquidity, accounting, and trading capability risks. Future investments may be made under different economic conditions, in different securities and using different investment strategies.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.