Emerging markets have been popular in investors’ portfolios for a number of years, on the back of their solid economic fundamentals, booming demographics and growing domestic markets.
They have reaped the fruits of decade-long reforms and orthodox monetary and fiscal policies, initiated after the Asian crisis in 1998, and showed resilience at the height of the credit crisis in 2008.
In the aftermath of the crisis, they have been prompt to raise interest rates in the face of rising inflation and strong credit growth, and this has been helpful in preventing their economies from overheating.
In the face of this success, some economists started to believe that emerging markets would ‘decouple’ from developed markets. But more recent events have proven that this is not yet the case. Emerging markets have become an intricate part of global markets via trade and financial flows and this has made them more dependent on global growth and more sensitive to global news flow and risk appetite.
While investors are keen to point out the strength of the Chinese economy and its role as the regional engine of growth, it would be hard to ignore the degree to which some economies such as South Korea and Taiwan are still heavily reliant on exports to developed countries for economic growth.
Funds to watch Three Year Performance
• This category only includes ASEAN country funds, which have benefited from the strength of financials and consumer staples stocks over the past three years, given that these two sectors account for almost half of the ASEAN index. Within the ASEAN region, Thailand’s stellar performance stands out. The Fidelity Thailand Fund is managed by Asian equity analyst Eric Choe, who is part of the wider team of Asian analysts at Fidelity. In keeping with Fidelity’s investment philosophy, the investment process relies heavily on the bottom-up research conducted by the team. The manager particularly likes companies with improving fundamentals not reflected in the share price, high quality management, strong free cash flow and balance sheets, and industries with high entry barriers. The approach is relatively benchmark aware.
• The Asian equity team headed by Devan Kaloo and Hugh Young (pictured) is at the helm of the Aberdeen Global Asian Smaller Companies Fund. The fund benefits from the extensive experience of its management team – who also run the firm’s global emerging markets and Asia Pacific offerings – and Aberdeen’s proven investment approach. The team aims to identify opportunities in the Asia small cap space and invest in a portfolio of 50-70 stocks, thought to be under-researched and undervalued,for the long term..
• First State Singapore & Malaysia Growth is managed in line with First State’s Asian and emerging markets investment ethos and process, which seeks well-managed companies with sustainable business models, predictable growth and low valuations. Alistair Thompson, who took over the management of the fund in August 2006, is an experienced member of the First State team. Risk is controlled by focusing on soundly-managed and financially strong companies, and by ensuring that the portfolio is well diversified. However, stock selection typically determines the sector weighting and therefore the sector positions can be significant relative to the index.
Susceptible to global woes
Emerging markets are not immune to external shocks and the eurozone debt crisis, which has been escalating for the past two years, is a good example of the macro risks impacting the region.
The crisis caused investors to repatriate their capital to the relative safety of their domestic markets – in particular in the summer of 2011 – and emerging market equities registered heavy losses as a result. The recent global slowdown had a strong impact on emerging markets as well and PMI figures, a measure of industrial activity, reflected this slowdown.
Finally, China was another major source of concerns earlier in the year as its housing market showed signs of ebullience and investors worried about a potential bubble and a hard landing, which could have been devastating for the region as a whole.
Funds to watch Newcomers
• Aberdeen has built a very strong franchise in Asian and emergingmarket equities and this is reflected in the firm’s funds beingrepresented in each of these categories. Aberdeen Global Frontier Markets Equity is one of the latest additions to Aberdeen’s suite of funds and is managed by the renowned emerging market team.The process is driven by bottom-up research and focuses on identifying quality stocks at attractive prices, in frontier markets.
• The Renaissance Sub Saharan Fund is managed by Sven Richter,who has over 16 years’ experience, having previously managedemerging market funds and frontier funds at Templeton beforejoining Renaissance. He is supported by two analysts, Paul Rossand Orrin Flugel. The process starts with a quantitative screen of the universe, based on liquidity, size and basic value. Fundamental research is then conducted to assess the quality of the business model, management, risk and valuations. The portfolio is built with consideration given to the macro environment, and reflects the manager’s conviction.
• The Robeco Asian Stars Equities Fund is a best ideas,concentrated Asian portfolio, managed by Michiel Van Voorst.The manager aims at identifying the Asian companies that are best placed to benefit from long-term growth trends in the region. The investment process is very bottom up and value oriented, with little regard paid to the benchmark. The fund also benefits from the 15 years’ experience of the manager and the support of the wider emerging market team at Robeco..
Equities on shaky ground
Since the beginning of the year, emerging market equities have been volatile. While the area started the year strongly on the back of the long-term refinancing operations (LTRO) in Europe which boosted investor confidence and caused inflows into the region, macro concerns – including the eurozone crisis, China’s hard landing and a global slowdown – quickly clouded the outlook and caused markets to fall in the second quarter.
As the eurozone crisis moved closer to a resolution in the summer, and as the US embarked on another round of quantitative easing to support growth, the region experienced gains. Year to date (to 31 Oct, 2012), the MSCI Emerging Markets Index is up 8.6% in dollar terms, with emerging Europe (+12.3%) and emerging Asia (+11.1%) as the strongest regional performers.
Latin America lagged the wider market with a return of 1.25% over the period; the region’s largest economy Brazil had a particularly tough time as slowing commodity demand from China impacted some of Brazil’s largest companies, such as Vale.
Encouraging signs
The situation, however, is changing slowly. Recent data out of China suggests that this hard landing was in fact a soft landing and, after several rounds of interest rate and reserve requirements rises, inflation and credit growth have moderated and PMI figures have shown signs that the economy is gaining momentum again after a lull. The transition to a new political leadership has also been well received and investors now expect a range of growth-oriented reforms.
A similar trend has taken place in other emerging markets, such as South Korea, Thailand, the Philippines or Mexico where there have been tentative signs that activity has picked up. In its October edition of the World Economic Outlook, the IMF expects growth to reach 5.3% and 5.6% respectively in 2012 and 2013 in emerging markets. This compares with 1.3% and 1.5% for advanced economies. China, while slowing, will still register a 7.8% GDP growth in 2012 in their view, versus 9.2% in 2011.
More importantly, the major emerging market countries that are China, Brazil, India and even Mexico, have started a long process of rebalancing. As their populations are becoming wealthier, their middle classes are growing and their economic models are moving from export-driven to domestic consumption-driven. This should help them become less dependent on developed market growth and achieve a more balanced development model.
China was another major source of concerns earlier in the year as its housing market showed signs of ebullience and investors worried about a potential bubble and a hard landing
Funds to watch Assets under managemente
• TThe JPMorgan Emerging Markets Fund is managed by Austin Forey who has 24 years’ experience and is supported by a dedicated emerging markets research team. The approach islong-term and the primary focus is on company fundamentals. Forey prefers companies that benefit from domestic consumption growth rather than commodity prices or currency moves. So the portfolio is typically dominated by the financials and consumer staples sectors. We have high regard for the proven process, reflected by the fund’s Morningstar OBSR Bronze rating..
• Templeton Asian Growth benefits from the consistent approachmanaged by an experienced emerging markets managementteam. Templeton has a long track record of investing in the regiongoing back to 1987 when Mark Mobius (pictured) started managingdedicated portfolios. The team seeks to identify growth stocksthat are trading at significant discounts and this also involvesbeing contrarian and patient. It believes security selection is themain source of alpha generation, so the portfolio can differ quitesignificantly from its benchmark. Thailand makes up a significant percentage of the fund and the portfolio features a small exposure to frontier markets with holdings in countries such as Pakistan.The strength and experience of the team, along with the rigorous process, justify the fund’s Morningstar OBSR Bronze rating..
• The chief attraction of Fidelity South East Asia is the manager,Allan Liu, who has been managing money since 1990. He appliesa flexible approach and his fundamental bottom-up style isfinely balanced by his strong awareness ofmacro trends and appreciation for whathas been discounted by the market. At the stock level, there is a bias towards growth companies as the manager is seeking attractively-priced stocks with above-average earnings growth potential relative to the sector or the market.The manager’s ability and experience underpin the fund’s Morningstar OBSR Silver rating.
Domestic success story
The long-term domestic growth story has been key to the success of some of the flagship emerging market equity funds. The Aberdeen Global Emerging Market Fund, for example has long been invested in quality growth companies which benefit from growth in the internal markets. The fund has large overweight positions in consumer staples and financials, two sectors which have seen very strong growth over the past few years.
This trend, however, has created a valuation gap between the more defensive quality stocks – favoured by these funds – and the more cyclical stocks, more sensitive to global activity.
As valuations for some of the defensive names reach new highs, some fund managers, such as JOHCM’s James Syme and Paul Wimborne or Baring’s Roberto Lampl, have been favouring cyclical stocks lately, as they felt that such high valuations were no longer justified and could be a sign of a bubble.
While in the long term, this may prove the right thing to do, as the trend continues to favour the more defensive stocks, these funds are more exposed and performance has suffered as a result.
We have selected a mixture of funds that investors can choose to gain exposure to the region’s economic dynamics.
