After ignoring emerging markets for well over a decade, strong returns and concentration risk in U.S. markets are prompting large institutional investors to reassess the asset class. But allocators are still focused on specific countries and sectors, not emerging markets broadly.
CHANGE Global, which manages emerging markets strategies for the $225.3 billion Teacher Retirement System of Texas and the $76 billion Connecticut State Retirement System, has doubled its assets under management in the past 12 months.
"I think we’re beyond an inflection point and interest is rising dramatically for emerging markets,” the firm’s founder Thea Jamison told Institutional Investor. "The public plans, the foundations, the endowments, are evaluating these areas and for the first time have a real sense of urgency about it.”
CHANGE Global recently landed a $50 million emerging markets mandate from the $27.4 billion State Universities Retirement System of Illinois as part of a larger search for more diverse and startup managers. Michael Schlachter, chief investment officer for Illinois SURS, said that a lot of the growth looks to be in non-U.S. equities.
“It makes sense to be weighted globally,” Schlachter said over video, adding that U.S. equities “have been on a tremendous run right now. I’m not going to call the next recession, but at some point this party will stop.”
The MSCI EM Index returned 42.7 percent for the 12 months ending in June, well above the S&P's 20.9 percent during the same period and the All-Country World Index’s return of 23.7 percent.
Jamison thinks the current emerging markets cycle “may be more rewarding and longer” than the previous bull cycle for emerging markets that occurred from around 2001 through 2010 due to pro-growth policies in developing countries. And large institutional investors are taking notice. "We feel the market hasn't caught on yet."
Jamison sees specific opportunities in Taiwan and South Korea, where technology and semiconductor-related investment is driving economic activity. She also pointed to conditions improving in Brazil after a prolonged period of unusually high interest rates, creating potential opportunities in Latin America's largest economy.
Emerging markets manager Matthews’ executive chair and portfolio manager Mark Headley agrees that “it’s an exciting time to be in the game.”
“We are tumbling into a new era where the U.S. is massively over-owned and emerging markets are significantly under-owned,” Headley explained. “These regions have hundreds of under-researched and misunderstood companies.”
Yet Headley said the broad growth story is still challenging. The asset class comes with intense headwinds, including an overcrowding of tech stocks. Technology is now about 44 percent of the MSCI EM, with just three stocks — TSMC, Samsung, and SK Hynix — accounting for nearly 30 percent of the index.
“China’s earnings are not in great shape and may be deteriorating given the global environment. Inflation in some of these markets is scary,” Matthews’ Headley shared. “But it’s a very diverse story, so it gives an active manager the chance to build a portfolio that can build through the noise.”
With that overconcentration in mind, Valbona Schwab, CIO at Children's Health in Dallas, warned about reading renewed interest as a broad-based vote of confidence in the asset class. “Some of it may be investors seeking exposure to the semiconductor and AI cycle through the EM benchmark,” she explained.
Dallas Children’s seeks attractive opportunities across the market rather than making a broad call that the asset class will outperform. The system also uses an extension program to get liquid benchmark exposure with downside management and an alpha overlay. And because technology — especially semiconductors in Korea — has become such an important driver of the index, they manage that exposure separately.
