Gaining market share in emerging markets portfolios by moderating extreme returns: The case of Peru

Abstract

Most countries compete for investments from abroad, whether the investment is made directly in the form of new ventures or indirectly through the shares of existing firms that are publicly traded. Both higher returns and lower volatility can attract a higher market share of global stock portfolios constructed by investors seeking positions in emerging markets, depending on the strategy such investors use to build their portfolios. These investors include mutual fund managers, pension fund managers, and savvy private investors. This paper tests three common investment strategies portfolio managers use: A) maximize “risk-adjusted” return based on Modern Portfolio Theory; B) maximize minimum return based on the minimax principal in Decision Theory; and C) maximize “absolute return.” The results suggest that reducing volatility by moderating extreme returns would increase Peru’s share of such portfolios and perhaps be more effective and attainable than increasing overall average returns. Using data from 1995 to 2014 for Peru as a case study, moderating (a form of “winsorizing”) its best and worst returns by 20% would have increased its portfolio allocations from 9.4% to 16.5% for Strategy A managers, and from 0% to 48.5% for Strategy B managers. Strategy C managers ignore volatility and are thus unlikely to be influenced by its reduction. From a policy standpoint, Peru might attain the moderation by adopting more liberal net operating loss carry back and carry forward provisions in the tax code similar to those in the US tax code, though this paper does not provide evidence that such changes would accomplish this result. The positive effect could be lost, of course, if other countries quickly retaliated by changing their own tax codes, but most governments are not known for being nimble when it comes to changing tax codes.