Emerging market equity benchmarks for Japanese investors: countries, sectors or styles?

Abstract

Japanese investors maybe considering adding emerging market (EM) equities to their portfolios. What type of baseline EM exposure might be most suitable for Japanese investors? Given recent improvements in benchmark technology, more extensive data coverage and empirical research in the underlying drivers of equity returns, Japanese investors can consider selecting, or designing, an EM benchmark that is most advantageous. The author shows that a traditional market-capitalization EM benchmark (e.g., MSCI EM index) may not be best-suited. Based on recent research showing that EM returns are influenced by sector and style exposures, in addition to country exposures, the author presents three alternative EM benchmarks that have provided better diversification, risk-adjusted returns and lower performance drawdowns for Japanese investors, compared to a traditional EM benchmark. Japanese investors should consider adopting one of these alternative EM benchmarks to represent their baseline EM allocation.