Global emerging markets attract strong investor interest despite high risk reputation
The global emerging markets funds sector has, over the past 12 months, outperformed all other equity-based peer groups and is attracting strong investor interest despite being what was traditionally considered the high-end risk of the investment spectrum.
This rise has been driven in part by the belief emerging market economies may lead the global recovery but also by the heightened risk appetite of investors.
With the UK and US heading towards a sustained period of indebtedness and de-leverage, investors may need to looking elsewhere for returns.
According to Morningstar, the average fund in the IMA Global Emerging Markets sector is up 81.9% over one year to 19 October.
The First State Investments Global Emerging Markets Leaders and Global Emerging Market funds are up 72.9% and 76.7% over this period respectively.
The vehicles were also first and third in the sector over three years with GEM Leaders up 72.7% and its older sister fund up 66.3%, compared to a peer group average return of 45.5%.
Co-manager Jonathan Asante says by building a portfolio of well-managed, mainly consumer-facing emerging market companies his funds should be able to beat a developed world equity benchmark index over the long term.
“Stocks that have added to returns in the past three years include Inbev, where we backed Brazilian management to take over, Anheuser and AngloGold Ashanti, where we again backed a new CEO to deliver much-needed improvements.”
However, Asante has a number of concerns about the short-term outlook for emerging markets.
“Having rallied very strongly, markets are no longer attractively valued,” he says.
“Our favoured stocks in Brazil, China and India are expensive and we believe there is limited value in the global emerging market universe. We do, however, continue to find some attractively priced quality franchises in the less popular markets of Israel and South Africa.”
Asante says he will continue to maintain a focus on “good-quality companies and superior stock selection.”
He adds: “At one end of the quality spectrum, falling input prices and cheaper currencies will be positive for the long-term profitability of a wide range of companies in our portfolio. In a downturn, strong managements really earn their keep and create stronger franchises.”
The manager remains positive on the long-term outlook for the sector as he expects economic growth to be higher than that of Western economies.
He says: “Our long-term view of economic growth should provide companies with excellent opportunities to boost sales and profits.
“Across the developing world there are an increasing number of quality companies with proven management and strong business franchises that are focused on long-term shareholder value.”
Baillie Gifford’s £255m Emerging Markets Growth fund is the top performer over the past 12 months, up 98.3%.
Co-manager Will Sutcliffe believes GEMs are still inefficient markets frequently driven either by short-term noise with local trading in and out of stocks on the basis of short-term sales numbers, or on the back of recommendations from analysts with little experience.
He says: “There is huge scope to add value by taking a step back, and looking at long-term underlying trends in terms of returns, and cashflows.”
Sutcliffe says the BG Emerging Markets portfolio has a bias to what he calls ‘emerging consumption’, including consumer cyclicals, financials, and technology.
He explains: “The resilience of recent GDP numbers at a time of sluggish exports really illustrates the extent to which domestic demand has taken over as the main driver of growth in many EM countries.
“The background here in consumption remains very immature in many EMs, but the macro background is now in place for the gap between emerging and developed consumption to start closing quickly.”
According to Sutcliffe, early in 2009 was the first time many EM countries had been able to respond to elevated levels of risk with significant fiscal and monetary stimulus.
In previous crises, he says, interest rates would usually have to be raised to support currencies and prevent investors rushing for the exits, while governments could not afford to throw money at the domestic economy.
Sutcliffe says: “This time it is different. Low sovereign debt levels mean many EMs are better placed than developed markets to stimulate their economies, while the fact interest rates are at new lows in many countries will have a huge impact on the emerging middle-classes, as mortgages, credit cards etc become available for the first time.”
He adds: “Underpinning all this is banking systems in most major EMs are actually working. These are frequently closed banking systems, so they managed to avoid the worst of the sub-prime mess, and have come through with healthy capitalisation levels and are now willing
to lend.”
Originally launched in November 1993, BlackRock’s £168m Emerging Markets fund is one of the oldest funds in the sector.
Returning 96.7% and ranked third over one year out of 30 funds, the vehicle has been co-managed by Daniel Tubbs, Dhiren Shah and Sam Vecht since April 2009.
In the second quarter, the portfolio benefited from the managers’ overweight exposure to Korea. The country was the largest positive contributor to performance, due to increasing GDP and both manufacturer and consumer confidence rallying strongly.
However, the fund’s lack of exposure to Indonesia, Asia’s best-performing market in the quarter, dragged on relative returns.
In Eastern Europe, Russia added significant value, boosted by both an overweight exposure and strong stock selection.
Tubbs says: “Elsewhere in Eastern Europe, Hungary’s OTP Bank continued to impress with shares up over 60% and second-quarter results coming in above expectations.
“In the Middle East, the non-index exposure to the United Arab Emirates proved beneficial, with shares rallying throughout the quarter.”
Brazil also added value with asset allocation and stock selection aiding strong relative performance.
“Cyrela Realty was the best-performing stock in the fund, benefiting from the improving economic background, decreasing interest rates and sales recovery, partly driven by the Brazilian government’s new housing plan,” Tubbs says.
“As the Brazilian economy continued to improve, consumer-focused names also did well. Elsewhere in Latin America, a lack of exposure to the weak Chilean market also added value.”
During the quarter, the managers continued to hold underweight exposure to China, trimming positions as stocks reached fair value.
“The Chinese growth story is well understood by investors and we believe there are markets where positive surprise is likely to occur. The large IPO pipeline may also decrease liquidity in the market,” Tubbs says.
The managers have recently increased exposure to Russia and Central Europe and retained a non-index position in the United Arab Emirates.
“In Latin America, we are comfortable with our Brazilian overweight given the continued positive economic data in Brazil,” Tubbs adds.
