Emerging Markets - Delivering on Investor Appetite

In the current low-yield environment, the prospect of 4.4% GDP growth in Emerging Markets continues to attract investors1. The combination of the latest macro-economic trends, the increase in passive flows as well as a change in approach towards Environmental, Social, Governance (ESG) strategies meets the growing investor demand for alpha. As emerging economies mature, together with the improvements made in corporate governance and the rise in index-inclusions, investor interest is likely to continue to grow – the question is whether market structure and trading access can evolve at the same pace.

Impact of market structure changes

MSCI’s increase in the weighting of Chinese Domestic A-shares from 0.71% to 3.3% in its Emerging Markets Index (EMI) in November 20192 provided international investors greater access to the local Chinese market, with MSCI estimating foreign inflows could reach $80 billion3. Saudi’s inclusion in MSCI (August 2019) and the FTSE, which is still on-going, is likely to see a similar increase in investor interest, with $18.2 billion of passive inflows predicted4 and a subsequent rebalance in Emerging Markets (EM) weightings for both index-providers.

Another factor is the growth in ESG, which has been a key topic for 20195 and which continues to rapidly gain traction. Historically EM as a sector has scored relatively low on ESG metrics relative to developed markets, but this gap is now closing as company value is reassessed globally and improved corporate governance is driving structural reforms. In a bid to support ESG promoting long term growth, the UAE have established its “first-of-its-kind” working group on sustainable finance6. The MSCI EMI is tracked by $1.9 trillion of global funds which may no longer be able to justify investing in companies which do not meet human and employee rights’ standards7. These developments will intensify the need for emerging economies to continue to address structural reform to maintain their growth. The scope for further future development is vast and will likely further increase investor appetite in EM as a result.

However, trading EM continues to pose challenges despite the investment opportunities available. The ability to source liquidity in an often more traditional approach to regulation and market structure can hamper secondary market activity, undermining the ability to enhance the investment process using technology and data.

Despite original fears that MiFID II would reduce the sell-side’s capacity to produce research and negatively impact the buy-side’s ability to generate alpha, it has played an instrumental role in raising awareness of the importance of execution, as well as the need to enhance data transparency to deliver improved execution outcomes for end investors. As workflows globally continue to become more automated, EM will need to match this evolution, as will its regulators to ensure international interest is sustained.

With risk capital no longer available as it once was, traders will continue to seek to source liquidity by alternative means. The introduction of new automated workflows using data and technology to uncover liquidity can lower implicit as well as explicit costs of trading, increasing the opportunity to generate alpha and enhance fund performance as a result. By breaking away from the more manual, resource-consuming methods, traders can access and interrogate greater quantitative analysis on liquidity formation, mapping investment objectives over a longer period of time, minimising unnecessary information leakage to source all important liquidity. The best guarantee for the future success of EM markets will be the ability to match investor appetite alongside improving execution at lower overall costs, delivering enhanced fund performance and sustained end-investor interest as a result.

EMEA Market Structure + Strategy Team

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