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Waverton: Massive ETF flows ‘distorting emerging markets’

Rapid inflows into emerging-market exchange-traded funds (ETFs) have distorted south-east Asian markets, according to Brook Tellwright, fund manager at Waverton Investment Management.

Tellwright, who has run the Waverton South East Asia Focus Fund since 2011, pointed to the huge inflows into emerging market ETFs this year as the reason behind the struggle of active managers to outperform the index.

The popularity of ETFs has created a “huge distortion” in markets, he said, with small and mid cap firms suffering despite having strong balance sheets and good prospects.

Tellwright, a bottom-up stockpicker who runs a concentrated portfolio of 25 to 30 mostly small and mid cap stocks, blamed the distortion for his fund’s underperformance in the first quarter of 2017.

The fund − a long-term top performer − rose 1.2% in March, and 7.2% over the first quarter of 2017 but lagged the MSCI Emerging Markets Index, which rose 3.1% in March and 9.4% in the quarter.

During the same period, the iShares Core MSCI Emerging Market ETF attracted $6.6bn of inflows, more than the $6bn which flowed into iShares’ S&P500 tracker.

Tellwright, who only holds six of the 160 stocks that make up the MSCI index and boasts a 98% active share, said: “When that massive amount of money enters relatively illiquid markets, it has a huge impact.”

He added that the south-east Asian markets were relatively inefficient, with poor research backing up stock-picking and that a strong active manager did have ample opportunity to add value.  

“The thing I have learned is that many firms in south-east Asia are not run for the benefit of shareholders,” Tellwright said.

He said large companies could be state-owned enterprises with political objectives or family-owned firms with “opaque” structures which he avoids.

With a number of firms lacking transparency, he agreed that investors focusing solely on large-cap stocks represented in the index could leave themselves at risk if they didn’t do the research needed.

Despite admitting he might be “tempted” to plump for large cap stocks in order to boost short-term returns, Tellwright said he would remain committed to his disciplined approach and would wait for a “pause” when markets would normalise.

“We might have to go through a cycle. I think people have to really see a market where they get very disappointing returns from ETFs and where active managers are able to perform well,” he said.

Part of the Mark Allen Group.