Monthly GEMs Equity Flows: ‘Active’ versus ‘passive’

Disclaimer & Disclosures Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it.  EM active funds have seen inflows over the past three months after facing continuous redemptions over the previous 16 months. In fact, EM active funds saw inflows only in 19 (out of the 69) months since January 2011. Over this period, EM active funds posted net outflows of cUSD136bn. In deep contrast, EM passive funds saw net inflows of cUSD30bn since January 2011 (see top LHS chart on page 2). EM passive funds showed a higher growth, compared with their active counterparts, in their AuM too. Whilst the AuM of the EM active funds grew less than 2x over the past decade, the growth in AuM of passive funds was higher at 9x (see top RHS chart on page 2). In fact the current total AuM of EM active funds is only at the levels seen in 2008 before the Global financial crisis. This trend – of preference for passive over active funds – was evident also in the overall equity (EM + DM) fund space (see bottom charts on the following page). This perhaps coincides with the period of weaker performance of the active funds relative to their benchmark. According to the analysis done by S&P and reported by FT1 “99% of actively managed US equity funds sold in Europe have failed to beat the S&P ______________________________________ 1 Almost all US, global and EM funds have failed to beat their benchmark since 2006, Financial Times, 24 October 2016 500 over the past 10 years, while only two in every 100 global equity funds have outperformed the S&P Global 1200 since 2006. Almost 97% of emerging market funds have underperformed”. Whilst the recent years have seen significant volumes of academic research that showed the attractions of the passive investing over active investing, a few papers have proved the contrary – at least for EM – in favour of active investing. For instance, the paper by Klemens Kremnitzer2 shows that “there is a strong relationship between active management and superior risk adjusted, net of fees returns relative to passive management in emerging markets.... in less efficient markets, such as emerging markets, information is less perfect and thus, for those who attain information unknown to most investors (like active managers), abnormal excess returns are higher”. Yet another possible point that favours active investing to passive investing within EM is the composition of the benchmark itself. For example with China, South Korea and Taiwan together making up more than 50% of the index, index investing could mean lesser diversification3. ______________________________________ 2 Comparing Active and Passive Fund Management in Emerging Markets, Klemens Kremnitzer, Economics Department, University of California, Berkeley 3 What the hell am I paying my EM fund manager for?, Financial Times, 12 September 2016 Kishore Muktinutalapati* Equity Strategist, Frontier & Emerging Markets HSBC Securities & Capital Markets (India) Pvt Ltd kishoremuktinutalapati@hsbc.co.in +91 80 4555 2756 John Lomax* Head of Global Emerging Market Equity Strategy HSBC Bank plc john.lomax@hsbcib.com +44 20 7992 3712 Issuer of report: HSBC Securities & Capital Markets (India) Pvt Ltd Published: 27 October 2016 *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations View HSBC Global Research at: https://www.research.hsbc.com Monthly GEMs Equity Flows EQUITY STRATEGY GLOBAL EMERGING MARKETS  Inflows are returning to active EM equity funds after strong outflows since 2011  EM passive funds saw inflows over this period and their total AuM grew 9x over the past ten years....  ....compared with less than 2x growth in AuM of active funds ‘Active’ versus ‘passive’ EQUITY STRATEGY ● GLOBAL EMERGING MARKETS 27 October 2016 2  EM equity funds: cumulative flows since 2001 EM equity funds: assets under management Source: EPFR Global, HSBC calculations Source: EPFR Global, HSBC calculations All equity funds (EM + DM): cumulative flows since 2001 All equity funds (EM + DM): assets under management Source: EPFR Global, HSBC calculations Source: EPFR Global, HSBC calculations -500501001502002001200220032004200520062007200820092010201120122013201420152016ActivePassiveUSDbn0.00.20.40.60.81.01.21.42001200220032004200520062007200820092010201120122013201420152016ActivePassiveUSDtrn-2,000-1,500-1,000-50005001,0001,5002,0002,5002001200220032004200520062007200820092010201120122013201420152016ActivePassiveUSDbn02468101214162001200220032004200520062007200820092010201120122013201420152016ActivePassiveUSDtrn EQUITY STRATEGY ● GLOBAL EMERGING MARKETS 27 October 2016 3  Fund flows 4 Cross-sectional comparison of Flow of Funds (% of AuM) 5 Monthly Flow (% of AuM) 6 Cumulative flows to EM and DM equity funds (% of AuM) 7 Cumulative flows to EM and