New Quantitative Global Emerging Markets Equity (Quant "GEMS") Strategy:  Bottoms-Up Stock Selection Focused

Our new Quantitative GEMS Strategy, we believe, provides investors with both alpha and liquidity.  The investment process is fundamentally based, consistent and disciplined.  This strategy is a departure from the top-down country allocation based quantitative strategy previously offered by EMM, and represents a quantitatively-based, bottoms-up, driven process of stock selection and factor exposure. In the Quantitative strategy, portfolio construction is based on the expected risk adjusted return of individual stocks in the emerging markets universe using EMM’s Quantitative Stock Attractiveness Model.  The Model is a synthesis of the two fundamental drivers of shareholder wealth (and, therefore, equity returns)—Valuation convergence and business change.  Potential valuation convergence is measured using globally-based (including both developed and emerging stocks) fair value models covering the global stock universe including developed and emerging stocks while business change is forecasted using fundamental business and stock price momentum.  Country allocation is risk controlled, and is a result of the bottom-up portfolio construction process – a tradeoff of the available active return from stock attractiveness constrained by risk management considerations. We expect country allocation risk to represent about one third to one half of the total active risk.

The Model's universe includes data on approximately 4,500 stocks from all world markets (emerging and non-emerging) and data is sourced from the EMM in-house database, Reuters, FTSE, S&P/Citigroup and MSCI.

(View the Stock Attractiveness Model)

Historical Global Quantitative Strategy:  Top-Down Country Allocation Focused

The EMM Global Quantitative Strategy Model is a "relative value" based tool that recommends country allocations across emerging markets. Because most active portfolio risk in a well-diversified emerging markets' portfolio comes from country allocation, we created a tool which addresses country allocation in a systematic and rigorous way. The "Model" calculates expected returns for individual equity markets, measures the trade-off between these expected returns and risk, relative to a benchmark, and suggests country allocations.

The model uses stock market and macro-economic data to derive expected returns for individual markets. Cash flows, earnings, dividends and earnings adjusted for accounting differences, are discounted in order to derive estimates of "fair value". Internal rate of return calculations, earnings revisions data, interest and exchange rates are utilized as well. Market correlations and historic volatility are also used as inputs.

Suggested country allocations are influence by the "strength" of the model signals (how far are current prices away from their "fair value") and the "clarity" of the signals (how well has the particular input successfully helped in forecasting). Together the strength and clarity of the signals determine how much a market should be over or under-weighted in comparison with a benchmark.

The model has been a part of Emerging Markets Management's investment approach since the Firm's inception in 1987. Although continually refined and upgraded, the model's "relative value" orientation has remained unchanged. A model such as ours is extremely helpful in processing and evaluating a huge variety of relevant data simultaneously and avoids a narrow focus on one or two factors that may temporarily dominate market sentiment. It makes explicit trade-offs between return and risk, includes long-term factors, screens variables that contribute to "noise" rather than reality, and attempts to optimize diversification.

How does the Top-Down Country Allocation Model work?

(View the Top-Down Country Allocation Model)

The model's foundation is built on the calculation and comparison of expected equity returns for individual emerging markets. In our process, we treat each individual equity market as a single stock with all the relevant characteristics of that market. We calculate expected returns for each market by weighting a collection of eight separate models of expected return, partly based on each model's individual historical predictive power. The models derive returns using different measurements of corporate cash flows but, at their core, they estimate equity returns as coming from future growth, current yield and market multiple reversion. All expected returns are calculated in real terms from a U.S. investor's perspective (by using purchasing power parity-based currency forecasts). Once expected returns are calculated, adjustments are made for stock market correlations, predictability and benchmark differences. Finally, the model suggests country weightings. The allocation model is run daily and processes daily price, interest rate and exchange rate information on about twenty emerging economies. It is recalibrated on a monthly basis. Data and Research Tools Country allocation model research is conducted internally using macroeconomic data (GNP per capita, inflation, interest rates and exchange rates) as well as stock market data (market prices and capitalization, expected corporate profit forecasts, earnings revision data and various measures of corporate cash flow). Research tools include econometric estimation software. Data sources include local country government sources, brokers, quotation service vendors, Morgan Stanley Capital International, Standard and Poors and International Financial Statistics (International Monetary Fund) data.