It's Really Easy to Invest in Emerging Markets
After a gain of 24%, our Mean Reversal strategy enters its second year
Emerging Markets have been in a funk for many years. Let me show you one picture:
I could have put it in simple words: CAGR from 2006 to the end of 2023 = 4.44%, maximum monthly drawdown = -61.73%. Ugly.
That makes EMs a whole lot less investible than for example the S&P 500 / SPY ETF, which during the same time earned 9.82% and lost a maximum of - 50.8%..
But last January, I published “Shall the Best Follow the Worst”, in which I discussed the potential of something quite different: simply buying the worst-performing Emerging-Market ETFs of the previous year.
I couldn’t backtest any variation of this idea to my satisfaction, but I still recommended purchasing Taiwan (-21.9% in ‘22) and a proxy for Hungary (-31.1%).
I chickened out on buying Hungary, but I did invest in Taiwan.
Slightly later, I added that I had regrettedly overlooked Mebane Faber’s strategy which is somewhat different from my idea, and as I am ashamed to say, rather superior:
In a backtest spanning 120 years (1903-2007), Meb discovered that a country that was down two years in a row then gained on average +19.03%.
If we're talking about three years in a row, it's a whopping +30.3%.
The candidates for this approach were Colombia and the Philippines, both of which had suffered losses during the previous two years. Subsequently, I recommended and bought both.
Here are the results of the respective ETFs for 2023 (source: Portfoliovisualizer):
Taiwan (EWT): +29.2%
Hungary proxy (MGYOY): +41.94%
Colombia (GXG): +24.94%
Philippines (EPHE): +1.26%
Average return: +24.34%
A potentially big problem: my original data source displays considerably different numbers for the countries’s indexes.
As of December 30: Taiwan +11.8%, Hungary +29%, Colombia -1.6%, Philippines -2.1%.
How can this be? It seems that while indexes tend to be calculated in the local currency, ETFs are often Dollar-denominated. Also, there is always a difference between a MSCI Index and an ETF that is based on the index — the latter often mirrors a lot fewer companies.
Obviously, we can only invest in the ETFs, so it makes little sense to focus exclusively on the underlying indexes. We want to make money, not just be on the right side of an investing principle.
That may create a dilemma: what if an index is a loser, but the ETF is a winner?
The solution might be to create one’s own ranking, which would be based on ETF performance only.
On the other hand — wouldn’t this disregard Meb Faber’s 120-year backtest?
I have yet to get to the bottom of this. Any ideas?
Let me know how you feel about this problem in the comments, please.
I’m satisfied with the 24%, which is pretty in line with this strategy’s 120-year performance history.
Granted, just buying and holding the Nasdaq index would have been even better. Remember though that this strategy is not a main investment asset; it is more of an international diversifier, so you can’t easily compare it to the Nasdaq.
(And anyway, anybody who had bought-and-held QQQ to gain this year’s +54% would have had to deal with 2022’s -33%, so merely looking at ‘23 would be cherrypickingish).
The buy-the-best-EM-loser strategy is a methodological diversifier, as well! In contrast to most other strategies that I use, this one is based on mean reversion, in other words, the idea that markets tend to overshoot in both ways.
Emerging markets are particularly herdy and bipolar; no fund manager in 2012 wanted their boss or their clients to ask them, “Why the hell are you still invested in Greece?” After which the Greek index rose more than 50%.
Also, I quite like “Rip van Winkle” strategies where you buy your assets, go to sleep for a year, and then (hopefully) wake up richer, without having to do anything, and without even the option of worrying about your investment.
What I am selling on Tuesday, January 2
I will selling everything but the Philippines ETF EPHE.
Granted, Colombia’s index indicates an almost-unprecedented fourth negative year in a row, which could be a very strong buy signal. However, after the ETF performed so well during 2023, I am inclined to think that most of the mean reversal potential in this asset is already priced in.
This is merely a judgement call. Feel free to stick with Colombia! And anyway, what I write here is not investment advice — it’s just a guy’s random financial thoughts, as goes without saying…
What I will be buying on January 2
According to my data source, the beautiful, interactive Emerging Markets Performance table, Malaysia and China have had three negative years in a row, so I’m buying EWM and MCHI.
I’m doubling down on the Philippines, which has also gone through three bad years.
In addition, I’m purchasing half-size tranches of South Africa (EZA) and Qatar (QAT), which are down for two consecutive years.
Thailand (THD) was this year’s biggest loser of all. I’m acquiring a half-size portion of THD too, even though after only one bad year it doesn’t fulfill Meb Faber’s criteria.
Why I am buying? Generally speaking, purchasing the last year’s biggest loser is often quite profitable, except when we’re talking about chronically ailing countries, as was for example Greece around 2011. It’s a judgment call to say that Thailand isn’t chronically ailing, but I think it’s not an unreasonable one.
See you again in twelve months…
Have a Happy New Year!
When would MCHI go up?
https://x.com/jasongoepfert/status/1753528788984492214
Very well written and researched article. It gives me an area to consider that I hadn’t previously. Keep up the fine work!