While emerging market equities have been a profitable sector to invest in over the long-term, returns have waned in recent years.
According to FE Analytics, the MSCI Emerging Markets index and the MSCI Asia Pacific ex Japan index have both eclipsed the returns of the FTSE All Share over the last 10 years, making more than 220 per cent.
However, our data shows that both have fallen short of the FTSE All Share over three years as a result of a slowdown in China, falling commodity prices and a strengthening US dollar.
Performance of indices over 3yrs
Source: FE Analytics
While Barings' research highlighted that more than half of intermediaries feel that an economic slowdown in China is still the major headwind facing the global economy, it also indicated that investors believe the negative sentiment towards emerging markets has gone too far.
Thirty-three per cent of respondents felt their clients should now be upping their exposure to emerging market and Asia Pacific ex Japan equities.
One way investors could play this turnaround is via investment trusts: as well as benefiting from an uptick in the underlying assets of the trust, measured by net asset value (NAV), overall returns would also be enhanced if discounts narrow as a result of improving demand.
Bargain hunters appear to have already been active: nearly all of the closed-ended funds in the listed global emerging markets sector are now trading on tighter discounts than they have over the last month or so.
Tom Tuite Dalton, analyst at Oriel Securities, says that it has been a difficult environment for bargain-hunting investors looking to gain access to long-term growth.
"Discounts were never really that bombed out in the first place," he said.
"Usually when sentiment turns against emerging markets or there is a time of crisis, then you can see discounts widen to as far as 30 or 40 per cent. However, while discounts did go out to around 10 per cent, they have started to come back in again," he added.
The analyst says that one of the main reasons why trusts did not see their discounts go out as far is because their boards have been much happier to protect discounts on the downside by buying back shares.
However, while discounts on the whole are narrower than they have been recently, Tuite Dalton says there is still value left in certain emerging markets.
One of his favoured closed-ended funds is the Pacific Assets Trust. Although its discount has tightened recently, he still recommends it as a "buy".
"Its discount has come in quite strongly," he said. "It is run by First State and as they have soft-closed some of their open-ended funds, this is understandable. However, you are still getting exposure to their trust at a 3 per cent discount."
"First State focuses on sustainable businesses and it is quite a defensive portfolio. We still recommend it, as from my point of view, while it may only be on a 3 per cent discount, it’s worth paying a bit more for quality," he added.
Our data shows that investors in the £185m Pacific Assets Trust have been well-rewarded over the last few years, despite the fact that sentiment has not been particularly positive towards Asian equities.
The closed-ended fund has returned 34.1 per cent over this time, which is nearly 30 percentage points more than its benchmark – the MSCI AC Asia ex Japan index. It has also more than doubled the returns of the sector average over this time.
Performance of trust vs sector and index over 3yrs
| Name | 6m | 1yr | 3yr |
|---|---|---|---|
| Pacific Assets Trust | -2.25 | 16.13 | 34.1 |
| IT Asia Pacific ex Japan Equities | -7.76 | 11.53 | 16.56 |
| MSCI AC Asia ex Japan | -6.1 | 5.05 | 4.72 |
Source: FE Analytics
It is a similar story over 12 months, with the investment trust more than tripling the returns of its benchmark. Pacific Assets is not geared and has ongoing charges of 1.27 per cent, though it does have a performance fee on top of that.
While Pacific Assets is Tuite Dalton’s favoured option in the sector, he also likes the Edinburgh Dragon Trust.
"It quite often depends on your time horizon when you decide on which trust you should go for, but Edinburgh Dragon is part of Aberdeen, which focuses on strong balance sheets, so it too is quite conservative," he said.
The Edinburgh Dragon Trust, which is managed by Andrew Gillian, is trading on a 9.22 per cent discount to NAV – wider than its one- and three-year averages.
While investors would have made returns of 299 per cent over 10 years, the trust has struggled more recently and has posted negative returns year to date. Its sector average and its benchmark are up over the period.
The £511m trust is 10 per cent geared and has ongoing charges of 1.27 per cent.
For higher risk investors, Tuite Dalton says Templeton Emerging Markets is a good choice as it is trading at a wider discount than the majority of its peers.
"Global emerging market trusts are much harder to analyse," he said. "However, Templeton Emerging Markets has the advantage of being the largest fund in the sector."
"It has around $1.9bn worth of shares, so you are able to trade it quite easily. Its NAV performance has been poor over the last year but it has performed well over five years. It is very much a contrarian play for investors hedging for a turnaround," he added.
As Tuite Dalton highlights, Templeton Emerging Markets has performed well over the longer term.
Our data shows that the closed-ended fund has returned 82.66 per cent over five years, almost 30 percentage points more than the returns of its MSCI Emerging Markets benchmark over that time.
Performance of trust vs sector and index year to date
Source: FE Analytics
Nevertheless, it has struggled recently and has lost 6.37 per cent year to date which means it has underperformed against both the index and its peers.
Templeton Emerging Markets is trading on a 9 per cent discount to its NAV. It is slightly more expensive than Tuite Dalton’s other picks, as it has ongoing charges of 1.31 per cent.
