Following one of the most tranquil years in stock market history, volatility came roaring back in late January and early February.
Many investors were calling for the inevitable return of volatility in 2018, ourselves included. That said, few foresaw how quickly and how violently that prediction would come to fruition. While there was some debate as to what exactly prompted the pickup in volatility (with everything from inflation to inverse volatility exchange-traded products to the all-encompassing “quants” being blamed), the bottom line is that the spike in the Volatility Index (VIX) left equity investors running for cover.
One thing we found interesting was that during the height of the correction, the MSCI Emerging Markets Index outperformed the S&P 500 by almost 150 basis points (bps) on the downside, with other emerging market (EM) strategies holding up even better.1 Given that the EM asset class historically has had a standard deviation about 50% higher than that of the S&P, EM investors who may have expected the performance of EM to be worse than that of the U.S. were likely pleasantly surprised.
Valuation’s Impact on Beta
The EM outperformance brings to mind a concept that Jeremy Grantham has written about: beta is a critical component of explaining relative performance, but valuation can influence beta. Assets that are more expensive relative to their history may experience volatility above their expected levels (and vice versa). When an asset’s price outruns its fundamentals, a downturn in the market can be disproportionally negative when the music stops.
This is the exact same idea that underpins WisdomTree’s original investment philosophy and why we focus on fundamentals. Regarding those fundamentals, within EM we remain encouraged by corporate earnings and believe that the attractive valuation currently offered by the asset class is being underappreciated. As such, the recent sell-off may have provided us with a live case study that validates the dynamic beta concept.
