The recent poor performance of emerging market equities has been well documented.
A combination of various macroeconomic headwinds, political risk and changing investor appetite has meant that they have underperformed against their developed market rivals by a considerable amount over the past three years.
Performance of indices over 3yrs
Source: FE Analytics
Despite those relatively poor returns, many commentators argue that the long-term emerging markets growth story is still intact because of those economies’ strong demographics and evolving middle classes, and investors should be looking at cheap valuations as an opportunity.
Although some managers – such as Insight's Sonja Uys – say that now may be too early to buy back into the sector, Walls (pictured) has taken the plunge and is buying a number of closed ended emerging markets trusts for his five crown-rated Unicorn Mastertrust portfolio.
“I have held emerging markets trusts in the past, but the last one to go was Fidelity Asian Values in February 2010. However, I was considering it at the back end of last year,” he said.
“Everyone believed that tapering would be the most damaging part but I sort of think that fundamental valuations, at 12.5 times earnings, are looking attractive. There have been a lot of downgrades, outflows and currency weakness but I have been re-establishing my exposure to emerging markets.”
Walls admits the sector is a higher risk investment at this point in time.
However, the manager tries to add value in his fund by making contrarian calls and finding discount value across the investment trust sectors.
This has worked for him in the past. According to FE Analytics, his Unicorn Mastertrust is the IMA Flexible Investment sector’s fourth-best performer over 10 years, best performer over five years, sixth-best performer over three years and third-best performer over one year.
Performance of fund vs sector over 10yrs
Source: FE Analytics
The manager says that the current discounts in emerging markets mean now is a great time for long-term investors to build up exposure to the sector.
“I scratch my head every day wondering if I am mad,” Walls said. “There is a contrarian argument here though, however.”
“There has been a massive amount of redemptions from emerging market mutual funds which have really accelerated over the last few months and I am concerned about the movement of ETF money.”
“However, we have invested in some pretty good managers that aren’t going to be buying all the constituents of the index. Perhaps there is more pain to come, but now is the time to be acquiring emerging markets exposure, not cutting it.”
“I think everyone is in agreement that the long-term growth story is still there,” he added.
The manager has bought four emerging markets trusts for his portfolio.
“I’ve added Pacific Assets, which we bought at around a 9 per cent discount. That’s already come in to 6.4 per cent. I have bought some in dear old Templeton Emerging Markets, which has been very unloved and is one of the sector’s worst performers.”
“However, I can understand why as it has been over-reliant on resources stocks,” he added.
The Pacific Assets Investment Trust is managed by First State, a group that is commonly viewed as one of the best for emerging markets exposure in the open-ended universe.
Pacific Assets is made up of 52 holdings and has a large exposure to India, Taiwan and Singapore. It is underweight China and Hong Kong.
It has performed well recently despite the numerous headwinds. It has returned 28.16 per cent over three years while its benchmark – the MSCI AC Asia ex Japan index – has made just 1.74 per cent. It has also comfortably outperformed over 12 months.
Performance of trust vs index over 3yrs
Source: FE Analytics
Its discount has narrowed further in recent days and currently stands at 5 per cent. However, it has been trading at a premium at certain points over the past 12 months. It is not geared and has a total expense ratio (TER) of 1.3 per cent.
Templeton Emerging Markets, however, hasn’t performed as well.
While it is the best-performing emerging markets trust over 10 years, with returns of 300 per cent, it has delivered double-digit losses over one and three years. It is currently trading on a 9 per cent discount, but Walls says that the trust’s board has been buying back stock at 10 per cent to protect investors.
Templeton Emerging Markets is not geared and has ongoing charges of 1.3 per cent.
“I have also re-established my holding in Fidelity Asian Values and for my sins have bought Aberdeen Latin American Income, which hasn’t performed very well,” Walls said.
The Aberdeen Latin American Income fund invests across South America’s equity and bond markets.
Brazil, understandably, is its largest regional weighting, making up 54 per cent of the trust, with Vale and Petrobas accounting for close to 10 per cent of its assets. This will have contributed to Aberdeen Latin American Income’s recent poor performance.
Brazil is dubbed one of the “fragile five” economies with a large current account deficit. Its currency has weakened substantially recently and concerns about its economic outlook have intensified since the Fed first warned that it would be tapering its quantitative easing programme.
Performance of trust since Aug 2010
Source: FE Analytics
The trust has lost more than 20 per cent since its launch in August 2010, but as the graph above shows, it was hit particularly hard by Ben Bernanke’s tapering speech in May last year.
It has a yield of close to 6 per cent and is trading on an 8 per cent discount, having reached an 8 per cent premium at certain points over the last 12 months.
It is 15 per cent geared and has ongoing charges of 1.82 per cent.
