Where Active Managers Should Dominate, They’re Flopping

In one of the least efficient asset classes — emerging market debt — just one in five beats their benchmark.

Dhiraj Singh/Bloomberg

Dhiraj Singh/Bloomberg

In the ongoing battle with passive funds, active managers argue that inefficient investment areas like small-cap stocks and emerging markets are where they shine.

But a report released Monday from Willis Towers Watson found that active managers are failing to beat their benchmarks in emerging markets debt, an area abundant with mispriced securities, bad data, and opaque counterparties.

According to WTW, less than half of managers have delivered returns above benchmarks over five, seven, and ten-year time periods, even before fees are subtracted. Once returns are adjusted for fees and other expenses, about 20 percent of managers beat their yardsticks for performance.

“Counterintuitively for an asset class with huge potential for mispricing and opportunity, asset owners have been continually disappointed,” according to the consultant’s report for clients on emerging market debt.

Willis Towers Watson attributed the dismal performance to some fundamental strategy mistakes by managers.


“What do Africa, Latin America, Central Europe, the Middle East, and Asia have in common? Very little. And yet investments in emerging market debt (EMD) remain dominated by broad, generalist funds that seek to span all of these areas and require a manager to possess skill in currency, country, and companies of all sectors and a huge span of completely different investments,” according to the report. “Perhaps unsurprisingly, the chance of any single manager having all of these skills is very small.”

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With emerging markets becoming a larger part of the global economy and allocators putting more money to work in the category, Willis Towers Watson argued that asset managers should do so some soul-searching.

Have investors and analysts on the ground locally instead of centralized London or New York, the consulting firm suggested. Likewise, local currency sovereign debt is very different from dollar-denominated debt and corporate bonds. Few of these investments can be handled by the same team, the report argued.

WTW recommended that pensions, endowments, and other institutional investors ditch ‘jack of all trades’ asset managers and instead hire specialists in each area.

“In general these managers ultimately offer little value-add to justify the costs,” the report argued. “The majority of managers are very large, developed market-based in terms of location and team and struggle to cover the huge breadth of potential opportunities in sufficient depth. Some others attempt to add value in every potential way.

The consultant also warns about the volatility in local currency sovereign debt, even though it has the highest potential return. “Most local currency managers do little to protect investors from drawdowns. This is particularly troublesome in stressed markets where increased correlation among EM currencies overwhelms the case for country selection,” according to the consulting firm.