Index Futures and the Expansion of Equity Markets in EM and Asia
Blog post
August 4, 2020
- Since the end of 2004, the size of equity markets in emerging markets (EM) and Asia grew significantly, as did the professionally managed asset pool targeting the region.
- Dispersion of subregional and single-market returns in EM and Asia has sometimes been sizable and was historically a bigger driver of stock performance than sectors and factors.
- Some investors may have used futures contracts based on regional and single-market indexes as they sought to complement their current investment process in EM and Asia.
Growth of EM and Asia Equity Active Asset Management
The period was also marked by the growth of regional-focused active strategies. During the 15-year period from 2004 to 2019, the aggregate assets of active EM and Asia regional funds tracked by the Thomson Reuters Eikon mutual-fund database grew at a 10.4% annualized rate, whereas the aggregate size of active EM and Asia single-market-focused funds grew at a 7.7% annualized rate.
The growth was supported, in part, by active managers' ability to generate higher alpha in EM compared to the developed markets (DM) over the same period,2 as well as the buildup of an EM derivatives ecosystem that extended the scope and flexibility of regional-based strategies.3
The Importance of Regional and Market Differences Within EM and Asia
The EM and Asia market is not a homogenous equity segment. To illustrate this, we break down EM and Asia into four subregions — Pacific; EM Asia; EM Europe, the Middle East and Africa (EMEA); and EM Latin America — and look at annual returns. The exhibit below shows that during the past decade, annual return dispersion between the best- and worst-performing subregions exceeded 30% at times.
Subregional Performance Rotations in EM and Asia
2020-Jun | 2019 | 2018 | 2017 | 2016 | 2015 | 2014 | 2013 | 2012 | 2011 | 2010 |
|---|---|---|---|---|---|---|---|---|---|---|
2020-Jun EM ASIA -3% | 2019 EM ASIA 20% | 2018 EM LatAM -6% | 2017 EM ASIA 43% | 2016 EM LatAM 31% | 2015 PACIFIC 3% | 2014 EM ASIA 5% | 2013 PACIFIC 18% | 2012 EM EMEA 22% | 2011 PACIFIC -14% | 2010 EM EMEA 24% |
2020-Jun PACIFIC -9% | 2019 PACIFIC 20% | 2018 PACIFIC -12% | 2017 EM EMEA 25% | 2016 EM EMEA 21% | 2015 EM ASIA -9% | 2014 PACIFIC -2% | 2013 EM ASIA 2% | 2012 EM ASIA 21% | 2011 EM ASIA -17% | 2010 EM ASIA 19% |
2020-Jun EM EMEA -21% | 2019 EM LatAM 18% | 2018 EM ASIA -15% | 2017 PACIFIC 25% | 2016 EM ASIA 7% | 2015 EM EMEA -20% | 2014 EM LatAM -12% | 2013 EM EMEA -5% | 2012 PACIFIC 15% | 2011 EM LatAM -19% | 2010 PACIFIC 16% |
2020-Jun EM LatAM -35% | 2019 EM EMEA 16% | 2018 EM EMEA -16% | 2017 EM LatAM 24% | 2016 PACIFIC 4% | 2015 EM LatAM -31% | 2014 EM EMEA -15% | 2013 EM LatAM -13% | 2012 EM LatAM 9% | 2011 EM EMEA -20% | 2010 EM LatAM 15% |
At the country level, the annual return dispersion of the best and worst performers reached as high as 70% at times, among the countries covered by the MSCI Emerging Markets Index.4
Given this wide dispersion of country-index returns, how did countries as a factor group explain individual stock performance over the period? The exhibit below shows that the country factors explained 40% to 80% of the systematic cross-sectional volatility (CSV) of both the MSCI Emerging Markets Index and the MSCI AC Asia Pacific Index from December 2004 to June 2020 — higher than the respective contributions from sectors and style factors.5
Importance of Country Factors in Driving Stock Performance Dispersion
How Some Investors Used Regional and Single-Country Index Futures
Given the dynamic performance rotation and dispersion across the subregions and countries of EM and Asia, some investors looked beyond traditional long-only approaches, including futures. Some have employed:
- Directional strategies: Investors long or short a contract, or a basket of contracts for a certain time horizon. For example, investors may gain exposure to an MSCI Japan Index futures contract to reflect their views on short-term dislocation of the Japanese market, or they may use a combination of MSCI Pacific ex Japan and MSCI China Free contracts to match exposure to a developed Asia-plus-China portfolio.
- Relative strategies: Investors match long position(s) with short position(s) within index futures to reflect their views on potential relative mispricing and market-dislocation opportunities. The exhibit below illustrates an example where an investor combined index-level fundamental data, such as price-to-forward-earnings ratio, to decide on tactical positioning of India vs. Taiwan.6
Relative Price-to-Forward-Earnings Ratio and 1-Year Forward Return: India vs. Taiwan
Box shows interquartile range (25th percentile to 75th percentile), and whisker shows minimum and maximum value. Dashed line in a box shows mean value.
Cumulative Performance of a Systematic Country-Rotation Strategy
We calculated monthly cross-sectional z-scores of three-month, risk-adjusted momentum and price-to-forward-earnings ratio for the MSCI China Free Index, MSCI India Index, MSCI Indonesia Index, MSCI Malaysia Index, MSCI Philippines Index, MSCI Taiwan Index, MSCI Thailand Index, MSCI Vietnam Index, MSCI Japan Index, MSCI Australia Index, MSCI Hong Kong Index, MSCI New Zealand Index and MSCI Singapore Index from December 2004 to June 2020. Index level is based on net total return in USD. Next, we calculated combined z-score for each index by subtracting z-score of price-to-forward-earnings ratio from z-score of three-month risk-adjusted momentum. Then, we calculated performance of a monthly rebalanced investment strategy that consists of an equally weighted long position of the three indexes with the highest combined z-scores and an equally weighted short position of the three indexes with lowest combined z-scores.
Investors may look to these approaches, and others, as they seek to enhance an existing investment process or potentially expand the scope of regional return sources.
The author thanks Shuo Xu, Wei Xu and Naoya Nishimura for their contributions to this post.
Further Reading
1According to the International Monetary Fund, EM and Asia will continue to be the major growth driver of the global economy in the foreseeable future. “World Economic Outlook.” International Monetary Fund, June 2020. Net issuance of new shares (e.g., initial public offerings and additional issuance) contributed 80% and 70% to the growth of free-float market capitalization of the MSCI Emerging Markets Index and MSCI Asia Pacific Index, respectively, from December 2004 to June 2020.2The average annual active returns of EM and DM active funds were 105 basis points (bps) and 65 bps, respectively, during the period April 2010 to February 2019. See: Melas, D. 2019. “The Future of Emerging Markets: 30 Years On from the Launch of the MSCI Emerging Markets Index.” MSCI Research Insight.3Sammer, B., Haiss, P., Gartner, M., Loistl, O., Zellner, S., Merton, R., Rybinski, K., and Sowa, U. 2010. “The Impact of Derivatives Markets on Asset Management and the Economy.” SUERF Studies.4In 2014, the MSCI India Index outperformed the MSCI Russia Index by roughly 70%.5By comparison, based on our analysis, country factors explained 13% to 44% of the systematic CSV of the MSCI World Index from December 2004 to June 2020.6Based on historical data from December 2004 to June 2020, the MSCI India Index more often outperformed the MSCI Taiwan Index during the subsequent one year when the starting relative price-to-forward-earnings ratio was below 0.8. On the other hand, the MSCI India Index more often underperformed the MSCI Taiwan Index during the subsequent one year when the starting relative price-to-forward-earnings ratio was above 1.5.
The content of this page is for informational purposes only and is intended for institutional professionals with the analytical resources and tools necessary to interpret any performance information. Nothing herein is intended to recommend any product, tool or service. For all references to laws, rules or regulations, please note that the information is provided “as is” and does not constitute legal advice or any binding interpretation. Any approach to comply with regulatory or policy initiatives should be discussed with your own legal counsel and/or the relevant competent authority, as needed.