Allocating Emerging Markets Based on Value
By Leila Heckman, PhD, April 7, 2021
To the chagrin of many value managers, value as an investment style for stock selection has not worked for much of the last ten years. This paper addresses how value has worked for allocating emerging markets. If one had overweighted cheap emerging markets and underweighted expensive emerging markets, how would that strategy have performed over long periods of time as well as the last ten years?
There are a number of measures of valuation. Using MSCI data at the market level, we have looked at price-to-book, trailing price-to-earnings, forecasted price-to-earnings, price-to-earnings relative to its 10-year average, earnings yield gap (difference between earnings yield and real short-term interest rates), dividend yield, and the CAPE (capitalization of the market divided by 10-year average earnings of the market).
We examine indicator performance based on tests of single-factor country allocation portfolios. Using dividend yield as an example, we calculate a score for every market each month based on how high the market’s dividend yield is relative to the emerging market average. Starting with MSCI Emerging Market benchmark country capitalization weights, we re-balance the portfolio monthly by assigning overweights to markets with higher-than-average dividend yields and underweights to markets with lower-than-average dividend yields. The portfolio is updated each month and performance returns (gross of transaction costs) are calculated monthly. Returns are then measured relative to MSCI Emerging Market Index returns. Below are the alphas of each of the value factors over a longer time period - from January 1997 through February 2021 and over the last ten years – March 2011 through February 2021. For the longer time period, January 1997 was chosen as a starting point since, at that point, there were over 20 emerging markets with valuation data
From the figures below, it can be seen that valuation at the market level as a factor for allocating emerging markets worked well over the longer time period but has not worked over the last 10 years. Three relatively inexpensive emerging markets over the last ten years (as measured by the average forecasted price-to-earnings) include Brazil, Turkey, and Greece. MSCI Brazil market has been dominated by Energy and Materials (each 25% of MSCI Brazil as of 3/1/2011). Greece has been dominated by Financials (55% of MSCI Greece as of 3/1/2011), but also during this period Greece was an epicenter of the European debt crisis. Turkey was dominated by Financials ( 56% of the MSCI Turkey as of 3/1/2011) and was subject to numerous political crises. More expensive markets which have done well over the last 10-years include Taiwan and India. Information technology was a large proportion of MSCI Taiwan Index (57% as of 3/1/2011) and was 18% of the MSCI India whereas it was 0% of the MSCI Turkey and MSCI Greece and 2% of the MSCI Brazil. Obviously, sector composition cannot explain all of the underperformance of value for allocating emerging markets over the last ten years. Economic, monetary, and political crises played a role as well.
We would expect that as economies recover, inexpensive stocks, sectors, including financials, energy, and industrials, and markets would come back into favor. This has been occurring in the U.S. equity market over the last 6 months. One could expect that as emerging market economies also recover, value as an investment factor could be a tailwind again for allocating among emerging markets.
Source: Heckman Global Advisors, MSCI, Bloomberg
Source: Heckman Global Advisors, MSCI, Bloomberg
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