Contact
START TRADING  

Financial News

World Economic Calendar

Contact us
We look forward to your feeback.

Trading Analysis

 
New call-to-action
Menu
Technical Analysis

Emerging Markets & The Remarkable Short Market Contribution

by Patrick Oberhaensli, on Aug 28, 2019 11:10:00 AM

Is it possible to sharply improve the risk-adjusted performance of global emerging markets equities using short-exposures? The answer is yes, by using short futures positioning at the level of the whole market. Not only is it much easier than with individual stocks, but it is also a very regulated market with, among others, no idiosyncratic risks. There are different ways to benefit from the characteristic drawdowns of the aggregated (emerging markets equities) market. In this article, we will explore these benefits in the context of a particular case study.


Cornèrtrader Demo Account

Searching For The Right Online Trading Platform?

FREE DEMO ACCOUNT WITH CORNÈRTRADER


Market Behavior Observations

A first observation comes from the massive drawdown during the 2008 great financial markets crisis, in which both global emerging markets equities and US large cap equities had their worst sell-off in recent years:

Global Emerging Markts Equities & US Large Cap Equities

That synchronal sharp price down movement is not a surprise and indicates that there is unlikely a decorrelation between the two markets when the investor needs it most. If one can extract value from a correct short positioning in US large cap equities during crashes, then it is likely helpful for emerging markets equities as well.

The key observation regarding the “flight to quality” phenomenon during times of strong equity market stress can help fill that value extraction. Given that emerging markets bonds are similarly affected, one can develop an out-of-market positioning. This observation is discussed further, in the context of asset allocation (not short or out-of-the-market positioning) in our article Combining Emerging Markets Equities With Bonds Exposure: What Is The Smart Way?”.

In other words, a relevant set of market behavior observations –not only from one market as is typical in trend following– when intelligently combined, allows the opportunity to develop the basis for new solutions. This is quite different from a purely statistical approach, especially at the level of the strategy optimization.


Global Emerging Markets Equities Long/Short Strategy

Examining, for illustration purposes, a proprietary global emerging markets equities Long/Short (L/S) strategy for the period starting in January 2004 up to the 12th of July 2019, including specific costs, we notice the following long-term characteristics:

Global Markets Equities LS Strategy

The result is that over this 15-and-a-half-year time period, global emerging markets equities L/S tripled the Sharpe ratio versus passive long-only (Buy-and-Hold)! At the same time, the result is with a clearly negative beta, meaning the strategy is not only a return enhancer but also a very good diversifier within the same segment.


Regional Perspective Long/Short Strategy

If we switch to a regional perspective with Latin America emerging markets large cap equities L/S for the same period starting in January 2004 up to the 23rd of July 2019, including specific costs, we find the following:

Regional Perspective LS Strategy

The results at a regional level, when considering the very high Sharpe Ratio, are even better. This is in line with the logic of the market efficiency theories at the regional versus global level.  These promote the idea that although there is more volatility and concentration (therefore less efficiency), there is also potentially a greater number of opportunities to be exploited.

A key aspect regarding Long/Short strategies is that the lack of a high ESG level for long-only emerging markets equities is at the same time greatly improved. Why? Because of the following reasons:

  • Since a risk-based strategy is not looking for trends, it won't get in a situation in which the strategy reinforces a trend (up or down) that is already in place.
  • It is fundamentally a liquidity provider (not a liquidity taker), meaning it benefits the market and should therefore be rewarded correspondingly.

Certainly a fascinating and important topic, we will be discussing ESG more extensively in future articles.


Conclusion

Overall, the risk-based approach adds substantial value particularly at the regional level. Unsurprisingly, the volatility is also a bit higher at the regional level than for the global portfolio.  However, volatility in this case is not a good measure of the level of risk.

Global emerging markets equities are more risky than the developed US large cap equities but generate less return long(er) term when remaining passive. This is a typical constellation in which the well-managed short-exposure possibility allows the achievement of abnormal high returns. In addition, the lack of efficiency of the large market makes it possible to obtain a negative beta portfolio, creating an effective diversifier within the asset class.


Does an Emerging Market Investment pay off in the long run?

Emerging Markets Equities eBook

This free guide has the answers to optimize your portfolio!

FREE DOWNLOAD NOW


Disclaimer:

In no event shall trading-boerse.ch its employees, officers, directors, affiliates, agents or licensors be liable to you or to any third party or to anyone else for any kind of financial loss, lost profits, any special, incidental or consequential damage or any other similar damage or any other loss or injury, resulting directly or indirectly from use of the site, caused in whole or part by its negligence or contingencies beyond its control in procuring, compiling, interpreting, reporting or delivering the site and any content on the site. Read more about our Privacy Policy.

Topic:Trading SignalsAsset AllocationDiversificationAnalysis and StrategyUS EquitiesEmerging Markets
Trading Platform Comparison

Find the Right Online Trading Platform

Read the Trading Platform Comparison Whitepaper Now

DOWNLOAD

 

Comments

About this blog

trading-boerse.ch is a personal finance blog. The articles posted provide relevant trading information, aspects, and opinions from expert professional traders and data and analytics providers.

New call-to-action

Receive Updates