Loren Fox, FA-IQ:
“Based on your view of emerging markets, do you think that that opportunity lends itself more to active or passive management? That’s to tie it into a big debate going on in the industry.”

Krishna Memani, CIO, OppenheimerFunds:
"This is an interesting issue. So, when we think about emerging markets, there are a couple of things that we think about. One, we think of emerging markets as one homogenous group. And the one thing that—coming from emerging market myself, the one thing that I can tell you is emerging markets are not one homogenous group. They’re very different, they’re very distinct and every single country has a different dynamic. So thinking of it as one group and one asset allocation I don’t think makes much sense.

“In addition, if you look at a market capitalization-based emerging market index, what you will end up owning in that context is steel companies in China and banks in China. Those have the largest weightings in the emerging market index.

“Ask yourself this question: Why are you investing in emerging markets? You are investing in emerging markets because you want a growth rate that is meaningfully higher than what you can get in the U.S. And, with a Chinese steel company and with a Chinese bank, you’re not going to get that. All you’re going to get is all their troubles.

“So I think, for large cap U.S., the case for passive is quite decent in a cost matter. For emerging markets, on the other hand, because of the dispersion of potential returns and dispersion of potential growth trajectories in different countries, passives is anathema in my view.

“If you go to emerging markets you are going there for singular reason. Singular reason. The growth rate in emerging markets, the companies that you invest in has to be materially—materially—higher than what you can get in the U.S. And buying an index doesn’t get you that.”

Loren Fox:
“Interesting. And, as the slide showed, even FT 400 advisors see U.S. stocks as a great place to use passive. Let me ask you, let’s circle back to U.S. stocks again. Given that they are at such high valuations, should that change how people think about the passive management opportunity in domestic equities?”

Krishna Memani:
"So, let me try to address that slightly differently. That is, I think in an asset class where dispersion is relatively modest, like large cap U.S. equity, I think the case for passive is quite compelling.

“Having said that, I think the one thing that you have to remember is, as passives have taken up your time, your mind share, what has that led to? What has that led to is significant amount of over-valuations in certain sectors of the market. So, if you buy passive strategies overall at current valuations, you’re buying certain things. You’re buying momentum. You used to buy momentum, didn’t buy momentum, buying momentum again. You’re buying growth more than others.

“The point of all of this is, even within the ETF world of large cap U.S. equities, there are opportunities to focus on specific sectors. And finding vehicles that deliver those specific exposures I think is important for you and your customers. So let me highlight a few.

“Sectors that we like. Financials. Over the next five years there’s going to be significant amount of release of capital out of these financials and they will deliver better results than they have over the last five years. They seem pretty attractive.

“Biotech. Biotech went through a significant correction the first quarter of 2016, hasn’t recovered much. The growth trajectory of the right biotech in the current environment is significantly better than the rest of the market. They offer good opportunity.

“For long-term investors, value is still extraordinarily cheap. It’s recovered some, it has given back a lot of that recently relative to growth. There are opportunities there.

“The point of all of this is kind of take a step back—one strategy is to devote part of your allocation to play in market cap passive strategy. But you can add value on top of that by focusing on specific sectors, specific strategies, specific factors that a particular fund delivers.”

The mention of specific stocks are for illustration purposes only and not a recommendation to buy or sell.

Carefully consider fund investment objectives, risks, charges and expenses. Visit oppenheimerfunds.com or call your advisor for a prospectus with this and other fund information. Read it carefully before investing.

These views represent the opinions of OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.

OppenheimerFunds is not affiliated with Financial Advisor IQ.

Investors look to active management for performance characteristics that are differentiated from the index. Areas of the market that experience greater dispersion may, on the whole, offer a better target for active managers. But an active allocation can benefit investors in asset classes with less dispersion, too, such as U.S. large cap equities.

Harnessing the Heterogeneity of Emerging Markets

Investors may allocate to emerging market equities in search of a growth rate that surpasses what is generally available in developed markets like the United States. But certain areas within emerging markets may offer better return potential than others—and passive strategies, which heavily weight areas such as Chinese steel companies and banks, often fail to capture this potential.

The Role of Active in U.S. Large Cap Equities

Even in U.S. large cap equities, which tend to experience less dispersion, combining active and passive strategies can add value. The flow of funds into passive strategies has created high valuations in certain sectors. In my view, adding exposure to more attractively valued sectors or investment factors may improve a portfolio’s return profile.

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