After a resurgence of interest at the end of last year, Paul Burgin examines the case for the Global Emerging Markets sector.
Last year was significantly more pleasant than 2011 for global emerging markets equity managers.
The average IMA Global Emerging Markets fund rose 13.32% in 2012, according to Morningstar, following double digit falls in the previous year.
British investors remain on trend, following the wider European pattern of ditching local equity growth strategies in favour of racier emerging market portfolios.
Geopollitical tension in Asia and the Middle East could muddy the outlook further
The IMA Global Emerging Markets sector was the third best seller in the UK in November, with net retail sales of £162m, well above its monthly average of £104m during the previous twelve months.
First State’s Global Emerging Market Leaders fund was the main beneficiary of inflows throughout the year.
Globally, heavy inflows late in 2012 gave emerging market equities a boost as investors increased their risk appetite.
According to Claire Peck, client portfolio manager at JP Morgan Asset Management, all emerging market equity classes benefited.
“Coming into September, we saw a bottoming of sentiment after two years of downwards earnings revisions. The year felt difficult but returns were relatively good,” she says.
Sentiment should continue to improve on the back of global liquidity and attractive valuations, which are currently around 1.6x times book, says Peck.
She is cautiously optimistic that improved economic data will draw in more investors. China will be the swing factor as stimulus and growth measures are stepped up.
The Aberdeen Global Emerging Markets Smaller Companies fund tops the performance chart over one year.
Its Global Emerging Markets fund, run by Devan Kaloo, is also a top ten performer, with returns of 19.27%. Kaloo says Aberdeen’s focus on quality stocks added to performance.
“In, at times, a difficult operating environment, these companies performed better, best evidenced in Q2 2012 when the fund outperformed the index by more than 3%. Our companies held up relatively better as the index fell 7% during the quarter,” he says.
Re-ratings of specific markets also added to alpha. Investors sold off in 2011 over inflation worries in Turkey, Mexico’s links to the US economy and political paralysis concerns in India. Kaloo held firm, adding to positions in quality firms in each market.
“In 2012, investor concerns dissipated and our holdings and the markets overall re-rated, adding significantly to our fund’s relative performance,” he says.
The Aberdeen Emerging Markets fund remains underweight domestic sectors, such as financials and consumer staples.
It is also underweight materials and industrials which depend on global growth. Kaloo also remains underweight North Asia, especially China, Taiwan and Korea where he struggles to find quality companies.
He awaits the results of stimulus measures in countries such as Brazil and India. Although recent evidence from China suggests an economic pick-up is underway, the country still faces issues.
“The new leadership faces a challenging transition as it seeks a more balanced growth. Aside from these macroeconomic headwinds, geopolitical tension in Asia and the Middle East could muddy the outlook further,” adds Kaloo.
However, Amit Mehta, manager of the JP Morgan Emerging Markets Small Cap fund, is positive on China, his largest country exposure.
He believes the outlook for Chinese smaller company stocks will improve as the focus switches to reform, infrastructure spending and domestic consumption.
He is keen on Chinese clothing and footwear, and financials in China, India and Brazil. Industrials are interesting too. “Smaller companies still trade at significant discounts. They all have a high correlation to domestic economies,” he says.
Mehta highlights the importance of strong selection and low portfolio turnover.
Emerging markets, particularly smaller companies, are still inefficient and trading remains relatively expensive.
His strategy is to invest through the cycle and to compound long term returns.
Jonathan Asante, co-manager of the First State Global Emerging Markets Leaders fund, also says quality stocks in consumer staples, financials, IT and healthcare performed better last year than lower quality firms in resources. However, some are now overvalued.
“We find many consumer companies to be fully- or over-valued in BRIC and increasingly in Africa too. Fortunately, there are still reasonably valued companies across many sectors that meet our quality criteria,” he says.
Global multinationals that deliver more than half of their business from developing economies look interesting too, he says.
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Juliet Schooling Latter, head of research, Chelsea Financial Services
Emerging markets are benefiting from improving corporate governance, a growing middle class and a number have access to an abundance of natural resources. Emerging market currencies should also appreciate nicely over the next few years.
Many global funds have a limited exposure to these markets currently so putting money in a fund specifically investing in these areas will give your portfolio better diversification.
Emerging markets have not fared as well as one might have hoped since the global financial crisis, often underperforming developed markets, and in particular the US. But I think we should start to see stronger performance come through in 2013.
One area which is seeing an increase in interest is income from emerging markets – we have seen a few new fund launches recently and I expect more to come. According to Morgan Stanley, 90% of emerging market companies are now paying a dividend.
My favored fund picks in the sector are: M&G Global Emerging Markets, Fidelity LATAM and JP Morgan Emerging Markets Income.
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