Quant investing in emerging markets

The fact that Traders Magazine recently ran an article titled “China: The Meteoric Growth of Quant Investing” is a sign of changing times.

Quant strategies in emerging markets may still be behind those in the developed world. But they are catching up.

The application of quantitative investing to emerging markets – traditionally a very volatile asset class – appears to be growing.

Indeed, Arup Datta, Head of the Global Quantitative Equity Team at Mackenzie Investments, confirms this. They represent, he states, a “sweet spot” for quants.

This is because, he says, that in emerging markets, some strengths of quant strategies compare favourably with the more traditional approach of fundamental investing.

Mackenzie’s models show that alpha efficacy has been higher in emerging markets than developed markets for the last 20 years. They believe, too, that they are likely to be so for the next 20.

So, while emerging markets may be less ‘efficient’ and less transparent than the developed markets of Europe and the US, this can be turned to a benefit.

“There is a greater breadth and diversity of names in emerging markets. That is a key advantage for quants over fundamental investors because they have a broader, rather than deeper, knowledge of the stock universe,” says Datta.

“Quants may also have proprietary risk and transaction-cost models, daily rebalancing and may be able to react quicker to the latest information.”

Similarly, the Financial Times reports that the asset management arm of Pictet, the Swiss bank, says emerging market equities could deliver “double-digit annual returns over the next five years”.

Why? The first answer, of course, is data. Data forms the front, centre and back of all quant strategies.

In China, and other emerging markets such as India, data is being driven by market liberalization, which is helping to fuel the charge for quant growth.

China’s measures towards economic liberalization, market reform and technological advancement, especially, are now making the onshore equity market more accessible and transparent.

This is backed by the fact that Chinese equities make up more than 30 per cent of the MSCI EM, followed by Taiwan, India, South Korea and Brazil.

Two decades of reform and the recent inclusion of A shares in benchmark MSCI indices have made China’s onshore equity market much more visible to non-Chinese investors.

The second answer is that we are now in a bear market. China’s zero-Covid policy is one big barrier to growth while Russia’s war in Ukraine makes the outlook look even gloomier.

What this means is that while the outlook for the rest of this year is unclear, these negative factors will (eventually) pass.

It’s why some investors feel now could be a good entry point for those with a five to 10-year horizon. EM stocks, in essence, are currently trading at a discount to those in developed markets.

Today’s composition of the MSCI EM, for example, emerging market enthusiasts argue, leaves these economies well prepared to bounce back from post-pandemic, post-war, post-stagflation world development.

It’s certainly the view of the world's largest independent investment bank, Lazard Asset Management, which has $188 billion AUM.

It states that historically, it has often 'paid' to buy China on weakness.

“While global expectations and sentiment have been muted for China, a market that has struggled over the past 15 months, often this type of environment marks a good time for investors to uncover new opportunities — and companies that are attractively valued.

"Following periods of sharp drawdowns, Chinese equities have bounced back close to 30% over the next 12 months and almost 50% over 18 months.”

But bottom line, the potential of emerging markets for quant investing is clear from this simple fact.

The importance of emerging markets in the global economy has increased significantly, driven in large part by China.

In 1980 emerging economies represented around 20% of global GDP. Today their share is 40%1.