In the ongoing active vs. passive debate, one dynamic that complicates the discussion is the fact that many “active” managers spend much of their energy simply trying to approximate their benchmark while adding a layer of market timing. At BMO Global Asset Management, we recently took a closer look at a subset of the investment universe we call “high-conviction” (HC) active strategies to assess whether they offer measurable benefits relative to index funds or low tracking error active strategies.
Our April 2018 white paper, “High-conviction strategies: Investing like you mean it,” provides empirical evidence that HC strategies in emerging markets have exhibited higher returns and lower volatility than their benchmarks and peers. The research also found that HC strategies tend to rebound strongly after periods of underperformance, suggesting that investors are well-served to remain patient with these managers and focus on long-term results.
Sources: BMO Global Asset Management, Morningstar Direct and Bloomberg L.P
Past performance is not a guarantee of future results.
While the benefits and characteristics of an HC approach are clear, how specific managers go about building HC portfolios varies significantly. LGM Investments, a subsidiary of BMO Global Asset Management, has applied a bottom-up, fundamental approach to emerging and frontier markets since 1991. We have identified several key aspects of our investment process, to show you how we go about constructing HC emerging markets portfolios for our clients.
1. Throw out the benchmark
When defining our investible universe of emerging markets stocks, we don’t use a benchmark as our starting point. Rather, we look across Asia, Africa, South America, and other developing regions for companies that have adequate size and liquidity. This results in an investible universe of about 1,000 companies.
2. Connect with the true growth potential of emerging markets
In developing economies, rising income levels and increased consumer spending fuel the long-term growth potential. That’s why we believe that if you follow the consumer, you’ll find the opportunities in emerging markets. We invest in sectors that derive their value from domestic consumption, such as consumer staples, banking, services, and telecommunications – goods and services that many consumers in developed markets take for granted but that are seen as aspirational or luxury items for the growing middle class in developing markets.
3. Know what types of companies you’re looking for
We believe that the companies that are best able to harness the secular tailwinds in emerging markets are those that exhibit the following characteristics: sustainable business model that allows the company to generate excess returns throughout the business cycle; robust balance sheet; proven management team; and clear and fair alignment between majority and minority shareholders. Moreover, we look for companies that currently have a dominant position in the local market because of advantages related to their brand loyalty, distribution capabilities, or scale. We then assess the durability of those advantages.
4. Hit the road to find these companies
Many of the companies in our universe aren’t covered by other analysts, meaning that there isn’t a consensus view. So, we pack our bags and hit the road to gain first-hand insights and develop our perspective. In the past year alone, this bottom-up, boots-on-the-ground approach has resulted in more than 900 company visits, including more than 200 on-site visits in over 30 different countries.
5. Invest with the courage of your convictions
Our goal isn’t to beat a benchmark. Our goal is to deliver attractive, absolute returns over the long term. We firmly believe in the secular growth story of emerging markets, so when we find companies that check all of the boxes and are trading at attractive valuations, we go for it and invest in that company for the long term.
Two defining characteristics of our HC approach are our time horizon and our portfolio concentration. Our five- to 10-year investment horizon empowers us to maintain positions in companies that we fundamentally believe in, even during short-term challenging periods. Our portfolio usually contains about 40 companies. While we prioritize maintaining an appropriate level of diversification across the portfolio, being more concentrated than many of our peers allows us to focus our efforts on the companies that we believe present the most compelling opportunities.
By consistently applying these principles – and doing it over the long term – we believe that we are well-positioned to find sustainable sources of alpha within the larger emerging markets growth story.
To learn more about BMO Global Asset Management’s specialized investment team and its approach to emerging markets, visit bmogam.com/potential
Source: Morningstar. Statistical data represents institutional separate accounts, gross of fees, with an inception date prior to 01/02/2012. Statistics for the HC universe and all subsets are calculated using the median monthly returns from 01/01/1998 to 12/31/2017. Composite information is self-reported to Morningstar by the managers and has not been independently verified.
Emerging markets data was filtered on the Morningstar Diversified Emerging Markets category. These portfolios tend to divide their assets among 20 or more nations, although they tend to focus on the emerging markets of Asia and Latin America rather than on those of the Middle East, Africa, or Europe. These portfolios invest predominantly in emerging market equities, but some funds also invest in both equities and fixed income investments from emerging markets.
All investments involve risk, including the possible loss of principal. The value of and income from any investment can fall as well as rise, and may be affected by changes in currency rates of exchange or taxation. An investor may not get back the original amount invested.
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Investing internationally, especially emerging markets, involves additional risks such as currency, political, accounting, economic, and market risk.
Investment products are: Not a Deposit — Not FDIC Insured — No Bank Guarantee — May Lose Value.
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