Limits, Schlimits

That a handful of index funds have trailed the broad-based MSCI Emerging Markets Index over the past six months?

I completely agree that investors should watch performance closely and consider various means of tracking an index. I’ll grant that swap-based replication is an attractive option in the emerging markets space.

But the limits of indexing?

For that to be true, you’d have to argue one of two things:

  1. Emerging markets are so materially inefficient that it is easy for active managers to outperform; or
  2. There is insufficient liquidity in many emerging market companies and their prices are being pushed around by the huge swathes of money invested in emerging markets index funds.

The first point simply does not hold. For the five years ending December 2009, 89.55% of all actively managed emerging markets funds trailed the S&P/IFCI Composite, according to the latest data from Standard and Poor’s. Your friend and his one-off track record aside, there’s no real-world support for the argument that active managers consistently outperform emerging market indices.

On the second point, you might have a case. The MSCI Emerging Markets index has become so dominant that you could argue that it’s being gamed around the edges. Certainly if you look back over the long haul, index tracking in the emerging markets space has been good. The Vanguard Emerging Markets Fund has delivered a 10.47% annualised return since March 2005, compared to 10.87% for the index. That’s not perfect, but it’s pretty darn close.

At the same time, however, it is true that money is flooding into the MSCI-linked funds. You could argue that this wave of new money has made the index ungainly, and that it is too easy for hedge funds to game asset flows around index transitions. If that’s the case, however, the solution is to use a different index, not to abandon indexing altogether.

I wouldn’t be surprised at all to see a wave of articles bemoaning “the MSCI Emerging Markets effect” and a pushback against the index, such as the one we saw a few years ago against the Russell 2000 small-cap index in the U.S.

That feedback pushed Russell to take steps to mitigate the impact of investment flows on the index. It also encouraged investors to adopt alternative small-cap benchmarks.

So is the recent underperformance of a handful of MSCI-linked funds the end of indexing? I don’t think so.

If anything, it’s the end of MSCI’s hegemony over the emerging markets indexing space.

  • Luke Handt

    Luke Handt is a seasoned cryptocurrency investor and advisor with over 7 years of experience in the blockchain and digital asset space. His passion for crypto began while studying computer science and economics at Stanford University in the early 2010s.

    Since 2016, Luke has been an active cryptocurrency trader, strategically investing in major coins as well as up-and-coming altcoins. He is knowledgeable about advanced crypto trading strategies, market analysis, and the nuances of blockchain protocols.

    In addition to managing his own crypto portfolio, Luke shares his expertise with others as a crypto writer and analyst for leading finance publications. He enjoys educating retail traders about digital assets and is a sought-after voice at fintech conferences worldwide.

    When he's not glued to price charts or researching promising new projects, Luke enjoys surfing, travel, and fine wine. He currently resides in Newport Beach, California where he continues to follow crypto markets closely and connect with other industry leaders.