The Alleged Inefficiency of Emerging Markets and Other Baloney


At Index Fund Advisors, we often hear from people all over the world who express an interest in the investment principles that we espouse. This pleases us greatly, as we have always felt that the benefits of index investing should not be limited to American investors. Recently, one of our contacts from India sent us an analysis of returns data on fifty of the most popular mutual funds domiciled in India (we were able to verify it with Morningstar Direct®). Specifically, all of these funds had returns data for the fourteen years ending 12/31/2013. Since we so often hear claims that the market may be efficient overall but there are still pockets of inefficiency such as emerging markets that talented managers can exploit to achieve outsize gains, we decided to use this analysis to test this assertion for India. One important caveat is that we are only looking at funds that survived to 12/31/2013. Since the attrition rate for U.S. mutual funds is around 7%, we would assume that it is at least that high for India. This would imply that there are at least another fifty funds that folded during the 14-year period, and it is safe to assume that those funds had subpar returns.

As with so many of the studies we have seen and done on our own, the amount of alpha that showed up was no higher than what we would have expected from chance. Twenty-four of the fifty funds had zero or negative alpha, and none of the remaining twenty-six had statistically significant alpha (t-statistic of 2 or higher). The minimum number of years needed to rule out luck in favor of skill was twenty years, and only two other funds required less than forty years. The standard deviation of the annual alphas varied from 15% to 40%, meaning that investors in these funds had to endure some disappointing years alongside the good years. Even the managers who had positive alpha made their investors pay for it by enduring a far higher risk than the benchmark*, so there was no free lunch to be had. The very simple pie chart below summarizes the results.

One important lesson we can take away from this is that if active managers within India have a difficult time capturing the elusive alpha by picking Indian stocks, what hope does an active emerging markets manager outside of India have? You know the answer.  

If any of our fans around the world wish to share any interesting data with us, we welcome the opportunity to provide feedback. Feel free to write us at [email protected]

*The benchmark used for this analysis was the Junior Nifty Index of Indian stocks.