The most common theme in emerging markets currently appears to be that there isn’t one. There’s slower growth in China, growing optimism in India, political uncertainty in Brazil and international sanctions in Russia. Each story is significant yet somewhat unrelated, making it difficult for banks and asset managers to package them for investors into a neat, tidy theme labelled emerging markets (EM).

Some EM watchers believe divergence of the economic and market outlook for individual countries has itself become the dominant story and that this won’t change soon. “Divergence in macro trends remains the overriding theme across the EM universe for now,” economists from Credit Suisse said in a report.

For the time being, different monetary policy directions among developed economies will likely continue to dominate global markets, including EM. The risk of higher interest rates in the US and UK may lead to a re-run of the taper tantrum that roiled EM last year, while the potential for greater monetary stimulus in Europe and Japan could bolster the case for yield-seeking EM carry trades.

Yet divergence between EM economies ensures that these factors will not affect markets uniformly and the question of the most effective approach to invest in EM - active or passive – remains more significant than ever. The active camp argues they have the necessary skill to identify value and capitalise on inefficiencies in EM, where liquidity is thinner compared with developed markets (DM). The passive camp says their approach makes managing market exposures efficient and cost effective in EM and DM alike.       

Some investors are already exploring ways to overcome the active or passive dilemma. Here are three of those ways:

• Blending is better: Why not include both active and passive strategies when it comes to emerging markets? Some investors who don’t have specific constraints when it comes to investment strategies believe pursuing both active and passive approaches - for example, through a multi-asset fund - includes the best of both worlds and achieves better risk-adjusted returns. Critics look at blended products and see a glass half empty; they warn that investors have to pay higher fees compared with purely passive funds and alpha may potentially be diluted by over-diversification. 

• A different kind of beta: Referred to as either smart or alternative beta, this approach deliberately deviates from the traditional “cap-weighted” approach, in which investors simply buy shares or bonds in proportion to their market value. Instead, investors can get more targeted exposure. For example, EM equities typically tend to be more volatile than their DM counterparts. However, a smart beta investor can purchase a minimum-volatility version of an EM equity index product to reduce the risk of choppy prices affecting returns. Supporters laud the flexibility to manage portfolio risk and potentially gain cost-effective exposure to everything from Islamic finance to Western multinationals that derive significant revenues from developing economies. Smart beta critics rightly point out that fees tend to be higher than purely passive investing tools and “smart” products can involve concentrated exposure to certain parts of the market. Investors need to be aware of the risks.

• Private and public: A growing amount of institutional investors have been happy to use passive strategies in public markets and aim for higher, uncorrelated returns in EM through private markets, such as private equity or real estate. An Emerging Markets Private Equity Association survey of 106 limited partners (LPs) from 30 countries showed 41% of LPs this year plan to increase the percentage of their total private equity allocation targeted at EM over the next two years, versus 32% in 2013. To enhance returns, some investors have been co-investing, or investing alongside managers, in certain deals. However, becoming a co-investor requires significant resources and expertise to source, analyse and execute deals in a limited timeframe. Not every investor will be able to do it.

The question of whether an active or passive approach produces higher and more consistent returns in EM may never really be answered, partly because the markets themselves are evolving amid a complicated economic environment. Nevertheless, expect the list of ways that investors are responding to the dilemma to continue to grow.

Investment strategies for emerging markets are the focus of a webinar from the Economist Intelligence Unit to be held on October 27 in Dubai. For more information about the free event, click here.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Economist Intelligence Unit Limited (EIU) or any other member of The Economist Group. The Economist Group (including the EIU) cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in the article.