"If you prefer making asset allocation calls and not thinking about choosing a manager
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and there can be quite a divergence in performance between managers in emerging markets
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in some respects an ETF is a relatively safe bet," he said. "You are not in danger of finding yourself in the hands of a manager who is cavalier with your money – as some have been – and you can fine-tune it and say at a certain time, for example, 'Russia is particularly attractive at the moment'."
Shaun Port, chief investment officer at Nutmeg – which uses ETFs to create low-cost portfolios for retail clients – agrees that the performance of managers in these regions has been patchy.
"According to the recent Vanguard study on active managers, 78 per cent of active managers in emerging markets underperformed over the past five years – largely as a result of the drag from high fees," he said.
Performance of sector vs index over 5-yrs
Source: FE Analytics
"Using a broad emerging market ETF will reduce fees compared with an active manager by at least 1 per cent per annum, so the cost savings are significant for long-term investors."
The relatively low cost of passive funds is one of their key attractions, but Cockerill says this on its own is a bad reason to buy them.
"Costs do gradually eat away at the returns. My instinct would be that if I had a choice I would always go for the one with the lowest tracking error."
"However, take the IMA Europe ex UK sector as an example. Over three years the index is up 2.7 per cent – my figures are a couple of weeks out of date – but Jupiter European, the fund we use for the sector, is up 38 per cent."
Performance of fund vs index over 3yrs
Source: FE Analytics
"I would say it is worth paying the extra fees for that kind of performance," he said.
Cockerill adds that the power of asset allocation is what makes ETFs attractive.
"I think you could look back over the past decade and work out that if you had allocated a certain amount of your assets to the emerging markets, you would have done very well."
"The research shows that asset allocation makes up to 90 per cent of your returns. I have always felt you make your asset allocation calls first – you decide that’s where you are going to get the best returns."
"If you can then enhance that by picking a better product, that’s great."
HSBC offers investors a number of products that focus on the emerging markets indices, from single-country funds to those that track regional indices.
While the company’s UK products are more established, the emerging market products have less of a track record to consider.
In theory, this should not be too much of an issue for passive funds – if they are tracking their index then performance data should be straightforward.
However, the issue investors need to consider is tracking error, which measures the extent to which a product diverges from the performance of the index it is supposed to be replicating.
Cockerill points out that tracking error can actually work in investors' favour – through the use of stock lending, an ETF can outperform its benchmark.
The tracking error on HSBC’s UK funds is relatively low – over two years HSBC FTSE 100 Index has a figure of 1.41 per cent, while HSBC FTSE 250 Index scores 1.25 per cent.
However, the products that track more exotic markets tend to have a higher score – the HSBC MSCI Brazil ETF has a tracking error of 6.89 per cent over that period and the HSBC MSCI Japan ETF scores 7.58 per cent.
Cockerill explains that this may be due to the fact that HSBC uses full physical replication on its products, meaning that it has to buy and sell the underlying stocks rather than using derivatives to mimic the returns.
Ironically this "natural" approach can lead to a larger divergence in performance, as the costs of buying and selling stocks detract from the fund's gains.
Port points out that the tracking difference – the difference in performance over discrete periods of time – is still relatively low; the Brazil fund, for example, has returned 0.81 per cent less than the index over two years.
He says that he uses the company’s single-country products but prefers other providers for broader exposure.
"We currently use Vanguard's ETF, costing only 0.45 per cent per annum – cheaper than it costs to invest in world developed markets (MSCI World) with iShares,"
"However, investors need to pay attention to the country mix in broad emerging market exposure – for example, do you want to have an 18 per cent exposure to China?"
"We find the HSBC ETFs very useful to gain more specific regional emerging market exposure to enable us to make more focused asset-allocation decisions – for example to invest in the Far East or Latin American markets."