In his book “Thinking, Fast and Slow”, Nobel Prize winner Daniel Kahneman tells a story about a curriculum project. The aim was to write a book that would help give high school pupils decision-making skills. After about a year, the team involved in the project, including Kahneman, made forecasts about how quickly they would finish the book. The team members’ estimates ranged between 1.5 and 2.5 years. Then Kahneman asked an expert in curriculum projects, who was a member of the team, how long did it normally take to accomplish similar projects for similar teams. The expert was surprised by his own answer: 40% failed and none achieved it in less than seven years. This was the “outside view” – one that was counterintuitive even for the expert who had all the data! In the end, the team took eight years to finish the project.

This ‘outside view’ concept can be used as one of the inputs when considering asset allocations across the equity markets of large emerging market (EM) countries.

If the aim is to outperform MSCI EM index over the next 12 months, the ‘outside view’ suggests:

  • Overweights in Brazil, South Africa and Russia
  • Underweights in Thailand and China.

It is far more important to understand country specific factors then considering outside view. You can find an analysis of such factors for the Russian equity market here: Will Russia outperform EM? Focus on Russia-specific factors. However, it is also important to have strong arguments in case of the opposite country allocation to the ‘outside view’ one.

(Please see the full version of the article with graphs in the attached pdf file.)

‘Extreme’ countries

In our ‘outside view’ analysis, we focus on countries which have demonstrated extreme outperformance/underperformance compared to the MSCI EM index over the last 12 months[1]. We do so because we believe that, in most cases, extreme performance – good or bad –is not sustainable. By extreme excess return we mean one that implies a difference of plus or minus one standard deviation from its long-term average. The countries that have recently posted extreme excess returns vs. the MSCI EM index are: China, Brazil, South Africa, Russia, Thailand and Mexico.

‘Outside view’ analysis

In the past two decades, the excess returns of China, Brazil, South Africa and Russia have followed a distinct contrarian pattern. Extreme past-12-months underperformance for these markets normally improved the odds and size of the outperformance in the following 12 months and vice versa. Thailand followed a momentum pattern. Extreme underperformance in the past 12 months for this market usually reduced the odds and size of the outperformance in the following 12 months and vice versa. We did not find it possible to come to a conclusion about the pattern type for Mexico.

To get the ‘outside view’ on the ability of individual equity markets to outperform the broad EM index over the next 12 months, we combine their performance over the last 12 months with their contrarian or momentum characteristics over the last two decades. For example, China equities over the last 12 months outperformed the EM index by 21%. This is more than 16.4%, which is the lower band for extreme outperformance. This band is equal to the country average annual outperformance over the last 20 years of 2.5% plus 13.8%, which is a standard deviation of the excess return of China vs. EM in the 12-month periods sample.  In the past, when China extremely outperformed EM over 12-month periods, it resulted in the outperformance over the next 12 months in 33% cases and the average underperformance vs. EM was 0.7%.


Authors: Egor Kiselev, Head of International Business & Investment Marketing; Gennady Sukhanov, Deputy Head of Equities & Head of Research

[1] From end of September 2019 to end of September 2020; top-10 largest countries within MSCI EM which country specific indices are available for the period 2001-2020

Ouside view on asset allocation across large EM October 2020
Categories: Research