The sector among top performing asset classes over past three years with average fund up 27.72% despite downturn in world markets
Global emerging markets have been among the top performing asset classes over the last three calendar years, with the average fund up 27.72%.
The sector was the fifth best performer over that time period, despite two years of largely negative returns. Global emerging markets lags only the closely related Latin America and Far East excluding Japan sectors and less correlated specialist and UK smaller companies funds in terms of three year performance.
The last two years have been difficult for the sector and world markets as a whole, but the excess returns of the 1999 technology boom continue to buoy funds' three year numbers, while the effect of Brazil's 1998 devaluation has now also slipped back into funds five year numbers.
Only a third of funds returned positive growth last year, with funds on average falling by 2.47%, bid-to-bid gross income reinvested, over 2001. In 2000, the sector was hit by an average drop of 23.42%, with no fund able to avoid double digit declines.
First State Global Emerging Markets is the second best performing fund in the sector over the last three calendar years, posting growth of 51.46%, equivalent to outperformance of 23.74%.
The AA-rated fund, managed by Angus Tulloch, head of global emerging markets at First State Investments, was the top performer last year, up 8.41% compared to a sector average down 2.47%.
Tulloch manages the fund from Edinburgh where he is supported by a team of eight analysts. Although decision- making is centred on Edinburgh, the global emerging markets team also has access to regional analysts based in Hong Kong and Singapore, as well as global sector analysts in London and Sydney.
The investment style of the fund is growth biased, although pragmatic enough to vary styles to suit market conditions. The bottom-up nature of First State's stock selection is also highly visible, with extensive company visits an integral element of the investment process.
Tulloch said: 'The strength of the team and the resources we have access to are a very major influence on the fund's performance. We are prepared to dig deeper and have an extensive company visits programme of over 1000 companies a year.'
The fund is managed with a multi-cap mandate and on an absolute return basis. Risk controls are therefore more concerned with ensuring capital preservation rather than curtailing benchmark deviation.
Tulloch added: 'We have risk parameters aimed at reducing the risk of losing money and none of them relate to index weightings. We don't have to be invested in certain markets but we cannot have 30% invested in any one sector without the prior approval of the chief investment officer.'
The portfolio typically comprises around 70 stocks, with the top 10 constituting around 30% of the fund. The top 20 make up 50% but Tulloch runs a long tail, enabling the fund to invest in smaller and medium sized companies.
The fund's ability to invest in favoured markets with few constraints has led the fund to outperform in each of the last two years.
Last year's positive returns were largely a result of stock picking in the outperforming markets of Mexico and Korea, the latter having been the best performing market in 2001.
Tulloch said: 'We had quite big exposure to some smaller and medium-sized Korean consumption plays and were a little overweight Mexico.'
The fund also benefited through indirect exposure to the strongly performing Russian market. Owing to concerns over standards of corporate governance in the former communist giant, Tulloch played the theme of Russian consumption through companies such as Gedeon Richter, a Hungarian pharmaceutical company selling into Russia, along with Finnish and Turkish listed brewers.
Similar concerns about the treatment of shareholders also limited the opportunities for Tulloch in the Czech Republic, although he stressed some markets, such as Korea, have made huge progress in this area.
The robustness of First State's investment process led to outperformance again in 2000, as the fund cut its telecoms, media and technology position and managed to avoid much of the downside. The fund was again the top performer in the sector in calendar year 2000, down 10.79% versus a sector average down 23.42%.
Tulloch's early sale of technology stocks and prudence in not overweighting the sector as heavily as his peers looked questionable in 1999. First State Global Emerging Markets was the bottom performer in 1999 posting growth of 56.61%, versus the sector average of 71.06%.
Tulloch said: 'We always like to understand what we invest in and a lot of the telecoms, media and technology stocks were difficult to understand. Many of the best companies in the global emerging markets universe are of the entrepeneurial type found in the sector but the valuations on some businesses were ridiculous.'
Subsequent outperformance of 12.63% in 2000 and 23.51% over the falling markets of 2000 and 2001 combined, affirmed the wisdom of reducing technology holdings and Tulloch remains underweight moving into 2002.
The Invesco Perpetual Emerging Countries Fund, managed by Bill Barron, has seen its medium-term numbers bounce back now that the 1998 performance data has fallen out of the three year figures.
Mike Kerley, who works alongside Barron and manages Invesco Perpetual's Emerging Countries offshore sister fund, said the fund's performance was hit in 1998 by holding an overweight position in Latin America in the run-up to Brazil's 1999 devaluation.
The fund returned -18.78% over the three years to the end of July 2001, versus a sector average of 0.45%, but like the sector Barron's numbers have seen a marked improvement since the turn of the year.
Over the last three calendar years, Invesco Perpetual Emerging Countries is up 13.97%, compared to a much-improved sector average of 27.72%. Stock selection is a product of country, sector and individual stock analysis, Kerley said. The portfolio generally holds between 80 and 100 stocks and is generally run with a large cap bias.
Kerley said: 'The average market cap of holdings in the fund is more than the benchmark, but that reflects that in a downturn, the ones that make it out of the other side are generally market leaders.'
The fund is currently country neutral, but overweight financials.
He added: 'Among financials we generally prefer banks but we would include property companies in that too. It is very country specific rather than an interest rate call.'
Kerley said there are numerous opportunities in the banking sector following restructuring across Asia in the wake of the continent's 1997 crash, while financials in other countries such as South Africa look very cheap too. Kerley is also bullish about the broader South African market now that he feels the currency has stabilised and he has bought into a number of materials companies, anticipating further consolidation in the sector.
While he sees opportunities in Argentina, following the country's recent problems, Kerley is downbeat about Mexico and Brazil, believing the countries both have very overvalued currencies.
Instead, he is preferring to up his weightings in the Asia-Pacific region. The fund is overweight the Republic of Korea and moving up to neutral weight in Taiwan, with Kerley starting to buy into the beaten down technology sector.
He said: 'We are moving back into semi-conductors in Taiwan. In a downturn you can identify those that are cheap, like Samsung. Companies like that will be market leaders and it is a big risk to be underweight technology in emerging markets.'
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