(Bloomberg) -- As large passive funds sweep through global markets, here’s one asset class they haven’t cracked yet: small-cap equities in developing nations.
That’s because the MSCI Emerging Markets Small-Cap Index has more than 1,800 companies, and the index provider makes a lot of changes with every review cycle, said Vikas Chiranewal, a Mumbai-based senior executive director for Franklin Templeton Investments’ emerging-markets group.
“Trying to track or duplicate that index has a very high transaction cost, and the tracking error is much higher,” said Chiranewal. “There are no large ETFs in the emerging-market small-caps space as a result.”
Their absence leaves room for active funds to dominate a market where revenue growth is close to 16 percent compared with 4 percent for the rest of the world, according to Chiranewal, who helps oversee $30 billion invested in emerging markets. Franklin Templeton manages $738 billion overall. The MSCI emerging markets small cap index rose 0.3 percent on Wednesday, extending its gains this year to 1.1 percent.
Here are some highlights from the interview:
- What are the advantages of investing in small-caps compared with other equities?
- “As companies are younger and smaller, they are much more nimble; decisions happen much faster, growth rates are much faster, their cost base is much lower, and so their profitability is much better. The revenue growth of MSCI world companies Index is just 4 percent whereas MSCI EM small cap Index growth is closer to 16 percent. Sector-adjusted valuations are also more favorable than large caps.”
- What is your position on emerging-market equities?
- “We are still very bullish on emerging markets. Emerging markets are now far more stable than they were before. We see on multiple parameters emerging markets continuing to do well for the next two years. Growth is still strong and political volatility is still low in major markets”
- “The main barometer, company earnings, are still rising. Currencies are not overvalued and valuations are still cheaper than their developed-market peers. The risk of U.S. rate increases leading to a collapse in emerging markets is limited because of much better macro fundamentals”
- “We saw a very large uptick in EM flows in 2017 and that run is continuing into this year as well. Funds like ourselves are receiving better attention overall from our end clients. We are adding positions in all our key markets such as China, India, Korea, eastern Europe and Latin America”
- What’s your view on the recent spike in volatility?
- “In any market you have some amount of volatility -- if there is no volatility people become complacent. And then it becomes a one-way street. EM and global volatility had gone down dramatically in the last couple of years”
- Where is your largest position?
- “India has been the largest country position for some years now. We think Indian companies will demonstrate fairly rapid growth over the next few years. Additionally, you have a fairly stable political regime. Our base case is that Modi’s government will be re-elected. That means we will have visibility on politics for a while. The reforms that have happened in the last two to three years are very good long-term reforms”
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