SINGAPORE (Apr 9): Implementing crisis-period exposure management and TAA (tactical asset allocation) policies through integrated futures may be an option as investors seek to manage through increased market volatility.
With market volatility rising to the highest level since the 2008 GFC during recent weeks, some investors’ asset-allocation policies may trigger a total portfolio rebalancing and exposure adjustment.
In addition, some investors may choose to implement TAA in an attempt to capture medium-term (three- to 12-month) opportunities within asset classes or market segments. For instance, as the Covid-19 pandemic unfolded, we saw initial underperformance and subsequent outperformance of the Chinese equity markets, leading to what some saw as a window of potential TAA opportunities.
Asymmetric beta of EM equities
The global equities market, as measured by the MSCI ACWI Index, returned –26.4% from Jan 31, 2020, to March 16, 2020, marking the biggest market drawdown since the 2008 GFC. By comparison, the MSCI Emerging Markets Index outperformed the broader market by 5% during the same study period.
However, from December 1987 through February 2020, emerging market (EM) equities more often underperformed when broad equity markets declined. Further, the EM drawdowns have historically been larger than those in developed markets (DM) during market crises.
Why? One reason is that EM equities have historically been a “high beta” asset class, and its beta during market downturns (1.4) has been higher than during market upturns (1.1). Emerging-market beta has moved as high as 1.9 during previous global market crises when the MSCI ACWI Index declined by more than 8% in one month.
This “asymmetric beta” feature of the EM equity asset class was due, in part, to the pro-cyclical nature of the EM currencies that is positively correlated to the economy and EM economies’ higher vulnerability to external shocks. As a result, managing EM equity exposure effectively during such challenging times has become a critical issue for global investors and asset allocators.
There are many approaches to implement exposure management or tactical asset allocation in investors EM/China equity allocations. Among them, three types of strategies were more commonly practised in the past: (1) direct transaction or over-the-counter (OTC) swaps in the cash and currency markets; (2) baskets of locally traded futures and transactions in currency markets; (3) integrated futures contracts such as the MSCI EM and MSCI China Index futures.
MSCI EM Index futures-trading activities during past crises
MSCI examined four main periods of market crisis since 2011, contrasting the EM cash market with the EM futures market in their patterns of trading-volume growth. In general, a significant rise of trading volume in both cash and futures markets was observed during crisis periods. Furthermore, the trading-volume increase in the futures market was much more significant than in the cash market, suggesting investors may have more heavily participated in the futures market during turbulent times.
Specifically, the weighted average turnover of the constituent stocks in the MSCI EM Index rose 30–70% during the studied market-crisis periods compared with normal trading days. On the other hand, the daily trading volume of the E-mini future based on the MSCI EM Index contract experienced sharper increases of 70–160% during market crises, compared with normal trading days.
