Somerset Capital Management portfolio manager Mark Asquith is backing "disliked" emerging markets in Latin America and EMEA within his new SMID-cap fund, and distancing himself from peers' portfolio favourites in an explicitly "contrarian" approach.
Following a "horrible decade" for emerging markets the MI Somerset Emerging Markets Discovery fund launched on 30 October near "the bottom of the cycle", according to Asquith, who said the portfolio offers investors an alternative to "index anchoring" peers.
The MSCI Emerging Markets index has the vast majority of its exposure to Asia, with China, South Korea and Taiwan alone representing 31.9%, 12.2% and 11.5% respectively.
This is reflected in the IA Global Emerging Markets sector, the funds in which have an average exposure to Asia Pacific equities of 49.3%, according to FE.
Asquith explained that while "most emerging markets investors will have the majority of their exposure in Asia, whether they are active or passive", the Discovery fund will be targeting the "economies and currencies that have been most badly hurt over the past three or four years".
Describing the approach as "80% bottom up", Asquith said the fund will differ to other emerging markets funds, which claim to be "focused on the idiosyncratic stock merits, but then control the country exposure and to some extent the sector exposure".
He added: "They will step back from taking any relative country risk by basically anchoring around the index weights by country, which in some way is a respectable approach - it takes away the nightmare of currency risk, for example.
"We are looking for the best companies we can get at the best price, [which] there is a lot more of in LatAm and EMEA in the small- and mid-cap range without those anchorings.
"You want to be a contrarian in this business and go to where the most disliked parts of the market are."
Deviation from the norm
Specifically, the fund will have comparatively high weightings in countries that have experienced "outright recessions… years of negative growth…and huge currency devaluations", such as Brazil, Turkey and Russia, he said.
Asquith added: "Coming out of [the poor economic performance] you have got at least the high probability of three years of rebounding economies from a very depressed level, whatever you think about the longer-term opportunity."
Having fallen by around 50% in the 18 months to January 2016 amid political turmoil, since then the MSCI Brazil has risen by more than 220%.
Asquith said "good valuations are available", even after the equity market recovery, adding that Turkey's small- and mid-cap universe has still got an average free cashflow yield of above 5%, "which is very good in terms of [return on capital] and free cashflow margin".
He added: "From a very depressed earnings environment, [Brazil is] turning into a more positive one, as well as valuations still not being expensive compared to parts of Asia."
The MSCI Russia has also performed well recently, delivering 36.1% over one year to 29 October compared to the 13.7% offered by the emerging market index overall.
Asquith said that while Russia "is a difficult stockpicking market", amid "endemic problems with vested interest that make the bottom-up difficult", its macroeconomic potential is "very strong".
He explained: "Russia has an almost 5% current account surplus with a very healthy balance sheet. If you are a pure macroeconomist, Russia is great. It also has very positive domestic and foreign balances."
From a sector perspective the fund will also differ in that it will have less exposure than the sector average to financials and tech, though this is primarily a function of the fund's SMID-cap focus and its relatively low exposure to Asia.
The fund will have a relatively large weighting in consumer discretionary stocks, targeting "what we see as the next stage of emerging market consumer investment behaviour", Asquith said, citing restaurant brands as an example.
Launched on 30 October with external and internal capital, including Asquith's own money, the firm is offering investors a six-month fee-free period in an effort to garner interest.
After that it will charge an annual management fee of 0.75% with no performance fee.
Sitting in the IA Global Emerging Markets sector, the fund will have no benchmark requirement and target approximately 36 companies with market capitalisations of between $500m and $7.5bn for its portfolio.
Asquith's small-cap fund has been closed to external capital for around seven years and Somerset will assess the size of the Discovery fund at $1.5bn in AUM, but will keep it open to existing investors.
The manager said: "We feel we are launching towards the bottom of a cycle and, paradoxically, just as we are beginning to get a bit of interest coming back to emerging markets after a horrible decade and a bad 2018.
"Fund managers want to launch when they see the opportunity and marketing often want to launch what clients want. It is an interesting conflict, and it often means funds get launched at the top when they should not be.
"Hopefully we have got the right inflection point - you have not got zero interest and we are still launching at the bottom with a lot of potential ahead of us."