Aperio Group, a financial advisory firm that manages customized equity portfolios, has published “The Case for Global Stock Portfolios.”  The white paper analyzes the trade-offs of managing investment portfolios with distinct mandates for emerging markets versus a global stock portfolio approach.

Aperio Group argues against the persistent myth that passive investing may not work in less efficient emerging markets. “The empirical evidence disproves the premise that emerging markets managers can successfully exploit the market inefficiencies and earn outsized returns,” writes author Michael Branch, CFA. “On an after-tax basis, our research in this paper shows that only 20% of active fund managers outperformed their representative benchmark and as Morningstar pointed out in ‘Morningstar Investor Returns,’ actual investor experience is often far worse than the composite numbers would suggest.”

Aperio calls for allocating long equity allocations globally rather than to smaller, more discreet mandates, pointing to the potentially costly and not often discussed risks of index reconstitution. A recent example of this was MSCI’s consideration to add Korea and Taiwan to the MSCI EAFE index. This move by MSCI would have resulted in significant portfolio turnover with expensive tax consequences for investors with narrowly defined international allocations.

The distinction between domestic, international and emerging markets is becoming outdated and artificial, Branch writes. “Correlations between emerging and developed markets continue to rise making it increasingly difficult to achieve the diversification benefits long associated with geographically-focused allocations. This is perhaps best illustrated by Coca-Cola. Coke is headquartered in Atlanta but derives approximately 80% of its revenue from outside the U.S. Is Coke an American or a foreign company?” Investors will do well to ponder this as they consider their allocation strategy, he suggests.