Morningstar Magazine - April/May 2018 - 28

Dispatches

topping actively managed equity funds for the
fourth year in a row. Since Morningstar began
collecting asset flow data on an industry
level in Europe in 2007, equity index funds have
seen higher inflows than actively managed
equity funds in absolute terms in eight out
of 11 years. At the end of 2017, the market share
of index equity funds stood at 26.2% of the
entire European equity-fund market, compared
with 24.8% at the end of 2016.
Against this backdrop, the passive challenge
in the bond-fund segment is much more modest
in scale. The fixed-income fund universe in
Europe remains firmly in the domain of active
managers. The market share of fixed-income index
funds amounts to just over 12% of the
European bond-fund market, compared with
11.8% at the end of 2016.
Meanwhile, there is a near-total absence of passive
allocation and alternative funds. That contributes
to the difference between the passive/active
narratives in Europe and the U.S. In the U.S., the
dramatic erosion of the active industry continued
in 2017. Actively managed funds shed close
to $7 billion in their third consecutive year of net
outflows, while passive funds recorded inflows
in excess of $690 billion. At the end of 2017,
the market share of actively managed funds had
dipped to 63.2% from 65.9% a year earlier. By the
end of 2017, almost every second dollar invested
in U.S. equity funds was invested passively.
The differences are obvious on a fund company
level as well. In the U.S., Vanguard recorded
net inflows of $345 billion, iShares took in $203
billion, and State Street STT enjoyed inflows of
around $34 billion. Fixed-income specialist PIMCO
was the most successful active manager, with net
inflows of just under $34 billion-thanks largely
to PIMCO Income PIMIX. In contrast, the
Vanguard story was a much more modest one
in Europe, where Vanguard funds saw net
inflows of EUR 15 billion in 2017. That's a far cry
from the flows to active managers of the likes of
BlackRock BLK, PIMCO, and Amundi.
Ali Masarwah is editorial director, EMEA, with Morningstar,
based in Germany.

28

Morningstar April/May 2018

Go Active in Russia
GREATER EUROPE

Netherlands
Russian stocks have become an area of interest
for many European investors, owing to their
low valuations. The forward price/earnings ratio
of the MSCI Russia Index was around 6 in
mid-February, compared with 13 for the broad
MSCI Emerging Markets Index.
Valuations have been depressed for a host of
reasons, ranging from weaker commodity prices,
Western sanctions resulting from the annexation
of Crimea, poor corporate governance standards,
and an aging population. Despite these risks,
contrarians argue that Russian equities now offer
a compelling value proposition.
In a February report, "Go Active in Russia: A
Landscape Report on Russia Equity Funds,"
we analyze the characteristics of Russia equity
funds available to European investors, including
concentration risks, performance, and fees.
Ultimately, we conclude that investors may be
better served using an actively managed approach.
There are many drawbacks to a standard
market-cap-weighted approach to Russia. First,
Russia equity indexes are highly concentrated
at the sector and stock level, which increases their
overall risk. Second, many Russian companies
suffer from poor corporate governance standards.
Active managers have been able to prove
their value by moving further down the market-cap
spectrum, screening for corporate governance
risks, and offering more diversified portfolios at the
sector and stock level.
At the end of 2017, there were 64 funds available
for sale in Europe in the Russia Equity
Morningstar Category, with consolidated assets
under management of approximately EUR 9.5
billion. Around EUR 8 billion was invested in
53 active funds, with the remainder in 11 passive
offerings. Morningstar analysts rate five active
funds that together account for more than
one third of the assets in active funds. Four are
Morningstar Medalists and one carries a

Morningstar Analyst Rating of Neutral. Meanwhile,
only the largest passive fund, Lyxor Russia
GDR ETF, has a Morningstar Analyst Rating, and
it is Negative. This reflects our conviction
that the exchange-traded fund will underperform
its active peers over the long term.
Most active Russia equity funds are benchmarked
to the MSCI Russia 10-40 Index, which spans
22 large- and mid-cap stocks, including depositary
receipts, preferred shares, and local shares.
Stocks are capped at 10%, and positions larger
than 5% cannot in aggregate represent more than
40% of the portfolio. This not only allows the
index to comply with UCITS diversification rules for
active equity funds but, by tilting the portfolio
toward smaller-cap stocks, also limits exposure to
state-owned enterprises.
Rated active Russia equity funds tend to be
benchmark-aware. That is, their portfolios do not
look very different from their benchmark.
Three out of the five rated funds hold almost all the
benchmark names.

Rated Russia Equity Funds
Name

Morningstar
Analyst Rating

Russian Prosperity (Luxembourg)

„

HSBC GIF Russia Equity

´

JPM Russia

´

Parvest Equity Russia

´

Neptune Russia & Greater Russia

ˇ

Lyxor Russia DJ Russia GDR ETF

Á

Source: Morningstar. Data as of 02/28/2018.

No passive fund currently tracks the MSCI
Russia 10-40 Index. Market liquidity is likely to be
a key reason. Passive fund managers may find it
easier to track indexes mostly composed of
depositary receipts (that is, American and General
Depositary Receipts). By trading on international
exchanges, ADRs and GDRs are somewhat
shielded from liquidity issues on the Moscow and
St. Petersburg exchanges. The trade-off, however,
is that these benchmarks have more concentrated,
large-cap portfolios. Indexes tracking depositary



Table of Contents for the Digital Edition of Morningstar Magazine - April/May 2018

Contents
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