In search of consistency

BlackRock recently upgraded its investment objectives for its emerging markets strategy to include the stock selection expertise that the team has developed over the years.

Jeff Shen , who is head of Asian and Emerging Market Equity within BlackRock’s Scientific Equity Portfolio Management Group, says “We focus on stock selection mostly and the stock selection opportunity set is looking quite good. Our investment strategies employ evidence-based judgment. We start with hypotheses about which investment strategies may lead to outperformance, which we then test to objectively validate or refute. This gives clients confidence that good past performance was due to skill and could be repeated.

Most managers in emerging markets spend the bulk of their time looking at individual stocks. In trying to build a repeatable investment process, BlackRock takes a more methodical approach to alpha generation. Shen says, “First we try to understand what types of information or what common situations cause market participants to consistently get things wrong. We then build tools that enable our portfolios to effectively capitalise on those market mis-pricings. Our investment process is able to quickly identify those alpha opportunities across nearly every liquid emerging market stock.

Shen’s primary approach on the research side is to empirically validate the firm’s economic and financial theories, using a broad set of quantitative tools and statistical models. At the portfolio level, the BlackRock Emerging Market Opportunities fund follows a diversified, systematic, industry-neutral approach that is designed to benefit from secular trends in the region as well as from temporary cyclical fluctuations. As such, it does not focus on sector or industry selection to deliver performance. Instead, BlackRock uses proprietary alpha forecasting and optimisation processes to build portfolios. Shen says, “The models allow us to understand and quantify complex pricing relationships across equity markets, and to identify which sources or factors of equity returns are slightly mispriced by the market at any point in time.”

One of the critical tenets of the BlackRock approach is a belief that, in the long run, fundamentals matter a great deal to stock prices. “We have a robust investment process built around tracking company fundamentals and changing investor expectations as they relate to the fundamental value of companies,” says Shen. “Our approach tends to do particularly well when there is sufficient dispersion among cross sectional stock returns.”

The managers adopt a global cross border perspective which allows them to compare companies within the same industry across different countries. Shen explains, “Using emerging markets industry peer groups for relative stock comparisons yields more meaningful relative valuations, while mitigating “thin industry” problems that are common to single-country strategies.”

The higher volatility of emerging markets provides a lot of opportunities to take profits on successful positions and reinvest back into more attractively priced options. Consequently, BlackRock manages this investment strategy with roughly 80-120% annualised turnover.

Although there has been much talk of institutions switching back their global allocations in favour of developed markets, the sector specialists, who have been covering emerging markets for years, continue to see a good economic story for developing countries on a secular basis. Shen says, “As equity investors, the critical component is how those future economic prospects are priced within each individual stock opportunity.  Subsequently we work hard to maintain a lot of investment diversity in the portfolio, thus most of the active risk is really expressed at the stock level.  Overall we think this approach provides more durable investment results.”

Institutional clients are long term investors in equity markets, so they tend not to be overly distraught during a market downturn or overly excited during the good times. What really matters most to them is a fund manager’s ability to continue generating market beating returns without taking large active risks.  

Shen says, “We take risk management seriously and view it to be a critical competency for our long-term success as active managers. Risk is managed by keeping strict limits on individual stock positions, as well as limits on overall country and industry exposures.

“For our emerging markets opportunity strategy in particular, we are very diligent in our search for new forms of risk that can impact equity markets. We live in a dynamic global economy where new risk factors arise quite regularly in developing markets. It is our job to ensure all the active investment positions are supported by our best research and to minimise uncompensated active risks.”