(Bloomberg) -- As investors scour the globe for under-valued stocks, one increasingly popular destination is actively managed exchange-traded funds that focus on emerging markets.

In the $350 billion market for ETFs that invest in developing-nation assets, the holdings of only about 5% of funds are actively managed — rather than pinned directly to an underlying index, according to data compiled by Bloomberg. But those actively managed funds have lured in more than a third of new cash that’s flowed into the asset class over the past year.

“If ever there was a compelling case for a more systematic approach to active management, it’s now,” said Donald Calcagni, chief investment officer of Mercer Advisors and a buyer of active emerging-market ETFs. “Look at all the dislocations that are happening globally, at valuations, at how concentrated markets have become.”

The reasons for the shift toward emerging-market shares are plenty. Developing-nation stocks are trading at a discount of about 43% compared to their peers in the US, just shy of the biggest valuation gap on record, data compiled by Bloomberg show. 

That chasm is a signal to some on Wall Street — including those with very few overseas investments — that developing-nation stocks are undervalued, offering an ideal moment to load up on the assets. 

Investors have been pouring cash into ETFs that wager on emerging assets in a bid to take advantage of lower fees and avoid the logistics of cross-border trading. That momentum is reigniting the debate over whether investors can eke out stronger returns in nimble, active strategies compared to passive ones that are beholden to a benchmark. 

Patrick Maynor, head of equities and portfolio manager at Trusted Capital Group, made his first foray into emerging-market funds by buying shares in the Avantis Emerging Markets Equity ETF, or AVEM, in April 2023. The ETF has posted a total return of 13.8% since then, beating its benchmark by about 3 percentage points.

It was a decision that hinged on the potential for value hidden in developing equity markets. Not only do the stocks trade at far cheaper prices than mature-economy peers, he said, but they also offer a way to diversify his firm’s $7 billion of assets under management. Maynor currently targets an allocation of 15% of his global equity strategy portfolio to AVEM, with the ability to “tactically increase over time.”

“Knowing my limitations on EM investing, it makes sense to partner with someone who does have expertise in that area,” he said. “I just know how hard it is investing in that landscape, and it’s certainly an investment space where you do need to have that active-type management.”

More than 95% of cash destined for actively managed EM ETFs in the past year has gone into strategies managed by Avantis Investors, a $40 billion investment offering from global asset manager American Century Investments, and Dimensional Fund Advisors, according to Bloomberg-compiled data.

ETFs from Avantis and Dimensional have lower-than-average industry fees and track records of outperforming passive benchmarks — two sticking points for the critics of active management.

Product issuers like Avantis are taking note of this strong demand. Since the beginning of last year, about 27 new emerging-market ETFs have come to market in the US, and at least 18 of them are actively managed, according to Bloomberg-compiled data.

For example, AVEM — the largest fund by assets in the category — charges a fee of 33 basis points, less than half the industry average of about 70 basis points across US-listed active ETFs tracking developing nation assets, the data show. The strategy has returned more than 15% for investors in 2023, while its benchmark only returned 11.7%, according to performance data provided by Avantis.

The outperformance has come even as AVEM keeps about 19% of its assets in China, where equities have been plunging. While Dimensional’s active emerging-market offerings also have a significant exposure to China, the strategy offers more emphasis on smaller companies and value stocks, said Rob Harvey, Dimensional’s co-head of product specialists.

“Investors say they still want their portfolio to look like emerging markets, but want it done in a little bit of a better way that they can get in an index,” Harvey said.

Product issuers like Avantis are taking note of this strong investor demand, adding new offerings to their product lineups. The fund manager launched the actively managed Avantis Emerging Markets ex-China Equity ETF, ticker AVXC, on March 21. On Monday, ETF issuer Global X Management Co. officially converted one of its actively-managed, broad emerging market strategies to an ex-China vehicle. Since the beginning of last year, about 27 new emerging-market ETFs have come to market in the US, and at least 18 of them are actively managed, according to Bloomberg-compiled data. 

AVXC, in particular, is capitalizing on a popular theme in the passive space — emerging-markets ex-China — as further evidence that investors want to make more targeted bets.

“The fear for an active manager is that if you get the China bet wrong, because it is such a big part of the EM index, there is a risk of ruin,” said Jane Edmondson, head of thematic strategy at TMX VettaFi. But also: “What if China rebounds?”

What to Watch 

  • Chile’s central bank is projected to cut the key rate to 6.5%, according to a central-bank posted survey of traders and investors
  • Poland is expected to keep interest rates unchanged at 5.75%
  • South Korea will post CPI data to reinforce the message that inflation is coming down

--With assistance from Srinivasan Sivabalan and Sid Verma.

(Updates AVEM performance in seventh paragraph. An earlier version of this story corrected the firm name in the third paragraph.)

©2024 Bloomberg L.P.