ing markets may be showcased best by Eling and Faust
(2010), which finds that emerging market hedge funds outperform their benchmarks but actively managed emerging
market mutual funds do not.
In this study we re-examine the question of whether or not
active management in emerging markets delivers outperformance by using a relatively new method of defining a fund’s
activeness. Specifically, we use the active share measure
created by Cremers and Petajisto (2009) and later used by
Petajisto (2013), Cremers et al. (2016), Cremers and Pareek
(2016), and Frazzini et al. (2016). This metric provides a determination of which active funds are truly active and which funds
are not as active.
The most relevant of the above papers to our analysis is
Cremers et al. (2016), because it examines activeness of internationally based funds. However, although Cremers et al.
(2016) includes some emerging market funds, their sample is
dominated by funds that hold assets in developed countries.
Moreover, none of the seven tables in Cremers et al. (2016), nor
the appendix to the paper, provide a specific breakdown of how
emerging market funds perform or the number of emerging
market funds in the sample.
Given the lack of specific analysis about emerging market
funds, we therefore believe our paper is the first to specifically
and solely examine the active share of emerging market funds.
To examine the question of whether more active funds outperform among emerging market funds we use a straightforward
method. Specifically, at the end of the year 2008 (when
Morningstar starts to provide active share data on emerging
market equity funds) we choose all actively managed diversified
emerging market equity funds that use as their benchmark the
MSCI Emerging Markets Index. This produces sixty-seven
funds. We follow these funds for the relatively long period of six
years (2009–2014). For these six years we examine the average
levels of active share of each fund and relate it to the performance of the fund, controlling for many factors. This six-year
period replicates the length of time a relatively long-term retail
investor may hold such a fund.
This paper represents the first attempt in the literature to specifically and solely examine the relationship between active share and emerging market equity fund performance. To do this we use a sample of U.S.-based actively managed diversified emerging market equity funds that we follow
for six years from 2009–2014. With this sample of funds, we
find a positive and significant relationship between the average level of a fund’s active share and fund performance. Funds
that are more active have significantly better performance than
other funds. We also find evidence that highly active funds
that keep the level of activeness consistent over time have significantly better performance than funds that vary the level of
activeness. Finally, we document that a significant number of
diversified emerging market funds were closet indexing over
the period 2009–2014, but that the percentage of funds that
pursue this strategy has been declining.
There is a prevailing wisdom that emerging financial equity
markets are less efficient than developed markets. De Santis
and Imrohoroğlu (1997) and Bekaert and Harvey (1997) find
that emerging financial markets offer significant growth opportunities but at the cost of high political and economic risk,
making them more volatile than developed markets. Because
this volatility is likely to be caused by local factors, it increases
idiosyncratic risk and thus allows active fund managers to place
bets that generate outperformance.
Despite this perceived inefficiency in emerging markets, evidence is mixed as to whether active mutual fund managers
can exploit these inefficiencies consistently. Gottesman and
Morey (2007) and Basu and Huang-Jones (2015) find little to
no evidence that actively managed emerging market mutual
funds outperform their benchmarks. On the other hand, studies by Huij and Post (2011) and Lin (2013) find that actively
managed mutual funds outperform their benchmarks.
Specifically, Huij and Post (2011) show that past winning
funds continue to predict strong performance, whereas Lin
(2013) shows that institutional, actively managed, emerging
market funds have positive and significant alphas over long
periods of time. The mixed nature of the results with emerg-
Active Share and Emerging Market
By Aron Gottesman, PhD, and Matthew Morey, PhD