Due to a fast-moving market, emerging markets fund managers have to keep their strategies proactive and aggressive to secure a return
Emerging markets have been undergoing a rally since the third quarter of this financial year. However, with the market moving so quickly, the degree of return achieved by managers depends on them using more proactive strategies and taking aggressive positions.
Several funds in the sector, including the GAM Emerging Markets Multi-fund and the Gartmore Capital Strategy Emerging Markets fund, have acted promptly to adjust their portfolios in order to the take advantage of the market. They have reallocated assets so as to increase the beta of their fund to try to ensure that any upturn in the market is reflected in the fund's performance.
Kier Boley, fund manager of the GAM Emerging Markets Multi-fund, explains: 'Emerging markets are cyclical in nature and in a rally the market moves strongly. In such a market, we want to ensure that our fund has sufficient beta element in the portfolio to take advantage of the market movement. The alpha element of the portfolio will produce a gain of 15% to 20% while the market might be moving by 20% to 25%. Hence the beta element of the portfolio has been increased so as to capture growth in a strong market.'
The GAM Emerging Markets Multi-fund, the second best performing fund in its sector over three years, is a multi-manager fund of hedge funds. With an annualised mean return of 15% and a beta of 0.73%, the fund invests 40% to 60% in hedge fund strategies and the rest in long only strategies. The beta was reduced through 2000 and 2001 because of slowing global economies. However the monthly beta has been increased to 0.8% and is expected to be 1% by January 2002.
Similarly, the Gartmore Capital Strategy Emerging Markets fund is the seventh best performing fund over three years with an annualised return of 14% compared to the average sector return of 3.16%. Its beta is the second highest at 1.2%. The fund has a rigorous investment philosophy that takes a top-down thematic, bottom-up stock selection approach.
Philip Ehrmann, head of Pacific and emerging markets at Gartmore, explains that the view on emerging markets is positive and the fund has been changed to take an aggressive stance hence to increase beta.
He says: 'The management takes risk very seriously and monitors the fund so as not to build too much volatility. The team meticulously chooses to invest in well-managed companies. We are foreseeing growth for the next year and have thus changed our position to take advantage of this by reducing our weighting on defensive sectors.'
The global market is still not out of the gloom yet, US and Japan are in a recession and it is premature to forecast a recovery of these economies. However despite this, emerging markets are in a rally. There are some macroeconomic factors that affect emerging markets and these sometimes are negatively related to the growth of the world economy.
Boley comments: 'The rally in emerging markets is triggered by anticipated recovery in the global economy and global rates cuts. Emerging markets tend to magnify the moves in the US economy. Moreover, recently we have seen a higher level of liquidity in the global market driven by the US rate cuts.
'Investors have been turning to riskier investments in emerging markets to meet their return criteria. Also interest rate cuts in the US allow emerging markets to cut interest rates in their markets because the spread of the yields remain the same, so not affecting the currency of the emerging market. When rates are cut the debt repayment burden falls.'
This has enabled the fund to take advantage of unexpected earnings growth.
'In any one year, analysts change their forecast for particular countries,' says Ehrmann. 'This represents a huge opportunity if you have your finger on the pulse and follow your own research. We identify themes or industries and within these we choose companies that are placed to do well. If we cannot justify a company's valuation within a sector then even if that sector looks positive, we do not invest in the company. For example, although we think that China has long-term prospects, we are currently underweight in China because there are question marks over the quality of company business models and the valuation of new companies.'
Ehrmann is looking at cyclical sectors. Those companies that have not invested in new capacity, but instead have undergone consolidation, are expected to show strong profitability.
He continues: 'In terms of countries, we have reduced our exposure to Latin American countries with the exception of Brazil and have concentrated in the surging Asian economies. We think Korea, Taiwan and India will do well. We are also overweight in Russia as the country's progress has been positive so far ' but the stock market might be affected by falling energy prices.
'Over the last 12 months we have changed our position from being overweight in energy to being underweight in the sector. The fall of oil prices has been good for the growth of the Asian economies but bad for Russia. We are overweight in the consumer discretionary sector and the financial sector and underweight in utility and consumer staples.'
Regression analysis: Regression statistics can be used to compare the relationships between funds, markets or a specific benchmark index. They do not make the assumption that the variables (funds) are related as cause and effect, but permit them to be influenced by other variables (markets).
Alpha: The Alpha describes the theoretical reward obtained by one investment when the second investment has a zero return. To calculate the Alpha, the returns of each are taken and compared together to identify their relationship. This reveals relationships between investments in both bull and bear markets. When applied to portfolios, it can be considered to be the return over and above (or below) the market through portfolio strategy. Good managers have a positive Alpha.
Beta: The Beta is the amount the first fund moves when the other moves by one unit. Beta is a measure of relative volatility (absolute volatility is calculated by standard deviation).
If one fund always goes up and down by 1.5 times of the performance of the index, its Beta will be 1.5. This implies that if the return of the index is positive, then 1.5 times this positive return can be expected of the fund. If the index goes up (or down) 10%, the fund goes up (or down) 15%. Beta represents the volatility of the first investment versus the second. It is only an estimate and to be accurate there has to be a perfect correlation between the two investments.
Monthly volatility (or standard deviation): Standard deviation is a measure of absolute volatility. It is the measure of the square root of the variance of each monthly return from the mean. The larger the figure, the higher the volatility of a fund and thus its risk. A typical example of the kind of funds and their associated risk ranging from low risk to high risk are: cash funds, fixed interest funds, balanced funds, UK equity funds, overseas equity funds and warrant funds.
Source: Standard & Poor's Micropal
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