Active Management and Market Timing: Unlocking Emerging Market Opportunities?

I would like to take a moment to introduce myself. My name is Matisse Cappon, and I'm excited to start working at Econopolis, a company whose vision and approach resonate with my perspective on financial markets. As someone passionate about active investment strategies, I've always sought environments where analytical depth and innovation are at the forefront. This passion guided my academic journey, resulting in a dissertation titled: Quantitative Analysis Of Tactical Asset Allocation Of Asset Managers: Do Asset Managers Add Value By Implementing Tactical Asset Allocation?

In this blog post, I’ll share some insights from my research on Tactical Asset Allocation (TAA, or market timing). Additionally, I’ll extend the discussion by applying these principles to emerging markets, blending academic insights with practical applications.

 

1. Passive or Active?

After years of dominance by the world’s largest technology stocks, passive investing has reaped the rewards. These mega-caps, which represent the biggest positions in popular indices such as the S&P 500 and MSCI World, have driven above-average returns for index investors. – The recently chosen word of the year in Belgium, hangmatbeleggen, further reinforces this statement. – In such an environment, professional and retail investors who like to shift weights have found it challenging to outperform the market.

However, as highlighted in my recent master’s dissertation, published in De Tijd, even during these times, market timing can be rewarding. TAA, a dynamic investment strategy, has the potential to add value when executed effectively. With 2025 looming, experts are patiently waiting for their moment to shine. The reelection of Donald Trump, heightened geopolitical tensions, and shifts in global economic policies could create the kind of volatility that makes TAA particularly relevant.

 

2. Practical Insights into Tactical Asset Allocation: A Case Study

Let’s dive deeper into TAA with a practical example out of my dissertation. In order to handle the confidential data with care, we do not disclose names of asset management firms.

A real-world example of TAA is seen with Asset Manager 3 (AM 3) during the 2020 Covid-19 pandemic. As shown in Figure 1, AM 3 increased its exposure to equities when markets initially dropped. They focused heavily on U.S. and European stocks, while reducing exposure to Japanese equities. This allowed them to ‘buy the dip,’ leading them to benefit from a swift recovery in developed market equities. As a result, AM 3 outperformed the benchmark in the short term.

However, as markets stabilized, AM 3 adjusted its strategy. They increased their weight in European equities but became more cautious on U.S. stocks, missing out on some of the big gains in the American market during the latter half of 2020. Despite these shifts, AM 3’s overall equity exposure remained overweight, maintaining relative outperformance. In the final months of the year, when AM 3 reduced regional equity allocations, they lost some of that outperformance, highlighting the challenges of tactical adjustments.

This example demonstrates how TAA can help investors manage risk and seize short-term opportunities, but careful execution is essential for long-term success.

 

Figure 1: TAA Example

 

3. More Opportunities Ahead?

As 2025 approaches, the opportunities for investors leveraging TAA continue to grow. Emerging markets, for instance, except for China and Argentina, are showing steady growth, driven by expanding economies and increasing consumer demand. Additionally, technological advancements such as artificial intelligence are reshaping industries, presenting concrete opportunities for strategic portfolio adjustments.

Especially regarding the recent news of emerging market stocks hitting a new low relative to U.S. stocks, market timing could come in handy here. Experts convinced of a clear pro or contra view on the asset class could profit from the extremely negative sentiment.

 

• EM Market Performance

In line with the story of passive funds outperforming, emerging markets are currently at an all-time low relative to American stocks. Even though performance across emerging economies is not dramatic, U.S. stocks are outperforming immensely. However, since inception of the MSCI Emerging Markets index in 2000, it outperformed the MSCI World Index with about 7.6 percent annualized against 6.8 percent for the index tracking worldwide equities. On a shorter time frame, though, things look very different. The index tracking emerging market economies underperformed the worldwide index on a 3-year, 5-year and even 10-year timeframe.[1]

The reelection of Donald Trump, with his preference for higher import taxes, has added to the challenges faced by emerging markets. This, in theory, presents a compelling opportunity for TAA. If the impact of these geopolitical developments proves less dramatic than expected, TAA enables investors to systematically increase exposure to undervalued emerging markets while effectively managing risk.

Figure 2: Ratio of Emerging Markets Stocks vs U.S. Stocks (source: X, @Barchart)

 

• Structural Growth Drivers in Emerging Markets

Economic developments across upcoming markets show a different picture. Such markets are playing an increasingly important role in the global economy, with some countries becoming major exporters and consumers of goods and services.[2] Emerging markets are underpinned by concrete growth drivers that set them apart from developed economies. For example, India is projected to grow at 6-7 percent annually over the next five years, driven by its young workforce, rising consumption, and government initiatives such as "Make in India" to boost manufacturing. Similarly, Southeast Asia, led by economies like Indonesia and Vietnam, is expected to see GDP growth of over 5 percent as global supply chains continue to diversify away from China and the region’s growing middle-class affluence. These numbers stand in stark contrast to the average annual GDP growth forecasted for the U.S. (2.1 percent) and Europe (1.6 percent).[3] However, just recently, BBC noted slower than expected growth in the ever-growing country of India of just 5.4 percent quarterly year-over-year growth while the Reserve Bank of India (RBI) expected a number of 7 percent.[4]

 

Figure 3: Economic Growth Across Markets

 

A growing working-age population, known as the demographic dividend, is a key driver of growth in many emerging markets. In India, the working-age population is projected to grow by approximately 7-8 million annually, offering significant opportunities for economic development. Likewise, Vietnam is benefiting from a demographic boost, with its young workforce driving growth in industries such as technology and manufacturing. In South America, regions like Brazil are benefiting from a growing middle class and increasing urbanization, creating demand for consumer goods and services.

For TAA strategies, such clear metrics allow investors to identify targeted opportunities. While broad passive exposure may dilute gains, increasing weights in sectors such as renewable energy, technology infrastructure, and consumer-driven industries in specific emerging economies can offer above-average returns. The MSCI Emerging Markets Index currently trades at a P/E ratio of 15.34, which is 35 percent lower than that of the MSCI World Index (23.54).[5] Moreover, as shown in Figure 4, this valuation gap is the widest it has been in the past decade. This presents a tangible opportunity for tactical investors willing to embrace calculated risk.

Figure 4: Premium MSCI World Index over MSCI Emerging Markets Index (source: Bloomberg)

 

4. Some Side Notes to be Made

However, as literature consistently confirms, market timing remains a heavily discussed topic. Most of the literature even denies the possibility of market timing. Especially when factoring in transaction costs, outperformance diminishes rapidly. Additionally, in such research where time is limited and data is selective, excluding all biases is practically impossible.

Furthermore, especially in the world of investing, absolutes like ones and zeros rarely apply, as the reality is always more nuanced. Emerging markets could be considered ‘cheap’ for a reason, as the quality of its economic growth, depth of financial markets and stability of political and financial systems may be less impressive than their developed markets’ counterparts.

 

5. Concluding Remarks

Tactical Asset Allocation (TAA) offers a strategic approach to managing investments in rapidly evolving markets. By adjusting exposure to emerging markets with strong growth profiles, such as India, Vietnam, and South America, investors can capitalize on high-potential opportunities, like fast-growing economies, while mitigating risks. Emerging markets are trading at a historically cheap valuation, presenting a favorable environment for active management and market timing. TAA enables investors to navigate these regions effectively, aligning portfolios with long-term growth while adapting to shifting economic conditions.

 

 

Sources:

[1] https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111

[2] https://www.imf.org/en/Blogs/Articles/2024/04/09/emerging-markets-are-exercising-greater-global-sway#:~:text=The%20global%20economy%20is%20increasingly,of%20Twenty's%20large%20emerging%20markets.

[3] https://www.imf.org/external/datamapper/NGDP_RPCH@WEO/OEMDC/ADVEC/IND/VNM/USA/EUQ

[4] https://www.bbc.com/news/articles/c8dq9rj63lmo

[5] https://www.msci.com/documents/10199/c0db0a48-01f2-4ba9-ad01-226fd5678111, as of 16/12/2024