The emerging markets asset class has grown tremendously over the past few years. Today, it encompasses a large number of different kinds of financial instruments from a wide variety of countries, for which there are a range of investment vehicles dedicated to getting the best this market has to offer.
Many emerging market funds are also extremely specialized and run by skilled professionals with deep local market insight. But does that in-depth specialization, and the knowledge a portfolio manager has of a particular region, country or asset class, necessarily result in a fund with superior performance?
According to a recent study entitled “Emerging Market Active Managers: Skilled or Stubborn?” conducted by Antonio Fasano, professor of financial markets and institutions at the University of Salerno, Italy, and the LUISS Business University in Rome, the answer is no: Specialization and deep local market insight have little bearing upon a fund’s performance.
That’s because fund managers with a thorough knowledge of a particular slice of the world or of a specific market segment are more often than not conditioned by behavioral biases that cause them to overlook some of the best investments in their niche area. These local market specialists, Fasano said, tend to become overconfident about their particular area, thinking that they know everything they need to know about it. This leads them to ignore key data that a manager of a broader emerging market fund might consider important, and that might help them eschew poor investments and select better ones.
“Let’s say by way of example that I am a Russian fund manager living in Moscow and running a Russia-focused fund: I probably have access to information that a foreign fund manager also investing in Russia probably can’t access, but I might also have too much confidence in the information I have access to, and think that something that is actually quite vital is not important at all,” Fasano said. “You can also think of this in terms of someone who lives in L.A. and drives their car everyday on the same roads and therefore underrates that risk compared to that same person taking a flight every once in a while and feeling discomfort flying.”
The same thing happens, he said, when investors evaluate companies. Very often, “a Russian manager dealing with Russian companies may underrate the risks associated with those companies compared to other emerging market fund managers who are managing broader portfolios and don’t have such a deep knowledge of the Russian market.”