Fitch Ratings says that a less supportive technical and macroeconomic environment in emerging markets provide more opportunities for active stock and bond investors.

Research by Fitch shows that actively managed EM equity funds have outperformed passive funds by 3% since December 2012. Furthermore, exchange traded funds (ETFs), which take a passive investment approach and track the MSCI EM index, have underperformed their benchmark by over 4%, demonstrating the difficulties in replicating an EM index in less efficient EM markets.

"Emerging market dynamics are changing. We expect actively managed, flexible funds to gain traction as EM fund investors exit directional play and managers become more selective in bottom-up selection," says Manuel Arrive, Senior Director in Fitch's Fund and Asset Manager rating team.

Nevertheless, ETFs remain the preferred option for swift adjustment of market exposure. ETF EM assets under management (AuM) represent a quarter of EM equity mutual funds but dominated outflows in 2013.

Dispersion, (ie. discrepancies in performance) is more distinct between domestic, single-country EM equity funds than between regional and global funds. As a consequence, first quartile single-country funds have outperformed their benchmark by over 12% over three years while global equity funds have outperformed by only 2%.

Country risk is becoming a more important driver of performance both for EM equities and for credit, as many countries have started to adapt policies to changing macroeconomic dynamics. The diminishing correlation between countries observed in 2013 and the impact of policy and government changes on individual companies have new implications for global EM portfolio construction.

EM corporate bond funds have outperformed other hard currency EM (principally sovereign) debt funds by over 5.5% since December 2012. Fitch expects EM corporate debt to continue to gain traction as they are more insulated from sovereign issues than government debt.

Fitch considers that superior bottom-up research provide an advantage for stock selection. Furthermore, the ability to allocate research resources effectively to cover an expanding investment universe is critical. Other key success factors in EM investing include the ability to get country and theme exposure right, taking account of sentiment and technical factors and managing liquidity effectively.

Fitch is publishing a presentation entitled "Emerging Markets: From Top-Down Allocation to Company Selection" that provides a summarised overview of the stock- and bond-picking developments in EM.

Fund sector research is part of Fitch's on-going commitment to fund research and ratings. Fitch's Fund Quality Ratings combine Fitch's experience in qualitative fund analysis with rankings and performance data from Lipper, a Thomson Reuters company. Fitch's Fund Quality Ratings offer an independent, forward-looking assessment of a fund's key performance and risk attributes and consistency of longer-term returns, relative to peer group or benchmarks. The ratings focus on the fund manager's investment process, key fund performance drivers, risk management, and the quality of the fund's operational infrastructure.

Link to Fitch Ratings' Report: Emerging Markets: From Top Down Allocation to Company Selection
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=742566FIN

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