A possible sector and mandate switch for the First State Global Emerging Market Leaders fund could adversely impact investors’ portfolios, according to Bestinvest’s Ben Seager-Scott.
Rumours are rife that FE Alpha Manager Glen Finegan and Jonathan Asante may move their five crown-rated fund from the IMA Global Emerging Markets sector to the unconstrained IMA Global sector, to allow the pair to invest in emerging markets indirectly via developed market stocks.
Seager-Scott (pictured), an investment adviser at Bestinvest, says that a sector change could mean that investors see their emerging markets exposure get watered down.
"You just want to make sure the fund retains the same focus," he said.
"They are very good in that space but there are two concerns I have if they were to switch sectors."
"Firstly, we would want to know what sort of emerging markets we are talking about. If it is a company listed in the emerging markets and derives its revenue from the emerging markets, that’s obviously fine."
"If it is a company that is listed on developed exchanges, Standard Chartered is a good example of this, as it derives its revenue from the frontier and the emerging markets – then that is also fine."
"However, the grey area is companies that receive some earnings growth from emerging markets, but that still get the bulk of their revenue from the developed markets."
"For instance, everyone knows GlaxoSmithKline has earnings growth in the emerging markets, but the bulk of its operations come from developed ones."
Even more worrying, Seager-Scott says, is that a sector shift could increase single-stock risk for many investors.
"The other concern is a key issue – how would the fund fit into a client’s portfolio?"
"You might get a UK manager who is getting growth from companies that have exposure in the emerging markets, like GlaxoSmithKline."
"But if you also held the First State fund you might be putting your clients in trouble because you don’t want to be doubling up on exposure."
"There could be a company that is held by equity income funds and UK growth funds, but when you throw in your emerging markets exposure you are becoming massively overweight on one stock, which is of course very risky."
If this was to happen, Seager-Scott says he would contemplate removing the fund from Bestinvest’s buy-list.
However, he adds there is little to worry about in the short-term as he feels any change to the fund’s sector is not on the immediate horizon.
"It is a very large fund. Both Aberdeen and First State capture the majority of retail client inflows into the emerging markets," he said.
"The thing I like about First State is that they are very good at active dialogue and anything they do they take time over. If anything was to happen, I wouldn’t expect it to happen immediately."
"When it comes to a change in mandate, we will have to wait and see. We are much more interested in what’s in the portfolio than the IMA, which has a very strict definition."
"The fund has already started to change its positions as it moved its exposure from the Hindustan Unilever to the parent company."
"They saw that even though the company derived most of its earnings growth from the Hindustan arm, the valuations were better for Unilever."
First State Global Emerging Market Leaders was launched in December 2003.
According to FE Analytics, since then its has returned 328.53 per cent while its benchmark – the MSCI Emerging Markets index – and the IMA Global Emerging Markets sector have returned 241.12 per cent and 234.63 per cent, respectively.
Performance of fund vs sector and index since Dec 2003
Source: FE Analytics
First State Global Emerging Market Leaders is also top quartile over one, three and five years.
The fund has done this with considerably less volatility than the index and sector, too.
This stellar performance has inevitably led to huge inflows, pushing assets under management (AUM) to £4bn.
The Share Centre’s Andy Parsons says that investors should not get carried away with criticism, as nothing has been decided yet.
"First and foremost, this is all speculation and I can’t stress that enough," he said.
"It is a highly, highly successful fund which has been extremely well managed by Glen Finegan and Jonathan Asante."
"It wouldn’t surprise me if other funds in other sectors over the next few years find they have a number of constraints on them. When, rightly or wrongly, a fund sees huge flows of money, by that very nature they become constrained."
"IMA Global Emerging Markets has a clear set of rules and definitions which means some managers can find themselves constrained as to where they can invest."
The official line from the IMA is that a fund in the Global Emerging Markets sector has to invest 80 per cent or more of its assets in emerging market equities as defined by the relevant FTSE or MSCI Global Emerging Markets index.
Investors who want access to First State have been pushed towards the Global Emerging Market Leaders fund as the firm has either soft-closed or slowed inflows into a number of portfolios, including its Asia Pacific Leaders, Asia Pacific Sustainability and Global Emerging Markets Sustainability offerings.
However, Parsons says he does not believe the fund would change sector in order to slow inflows, or to allow it to draw more money from investors.
"Of course, this is all very hypothetical. However, I don’t think it can be seen as a means to an end for this fund," he said.
"They have attempted to slow inflows into other funds and this is huge at £4bn, but I think a move would purely be to have a more flexible investment mandate."
"I think when people think of emerging markets, they think of a variety of opportunities. However, there is by no means the depth and breadth as you can find in the developed markets, so it can impose restrictions on some managers."
"If a manager sees opportunities in companies that trade on other more westernised exchanges – be it Europe, UK, US or other Asian countries – that service or manufacture products in the emerging markets, then that is another way of playing the global emerging markets theme, in my opinion.”
"If a manager can have more flexibility, then I am all for that," he added.
First State Global Emerging Market Leaders has an ongoing charges fee (OCF) of 1.58 per cent and requires a minimum investment of £1,000.
First State was unavailable for comment.