Emerging market equities have underperformed against their developed market rivals for some time now as investors have become concerned about the impact of the Fed’s QE tapering, slowing economic growth and currency weakness.
The year 2014 started in a similar vein. While the FTSE All Share has recovered from the January correction, the MSCI Emerging Markets index is still down 4 per cent.
Performance of indices in 2014
Source: FE Analytics
A number of industry experts, such as Unicorn’s Peter Walls, have started to re-establish their exposure to emerging markets because they say there are a number of good value opportunities in the developing world.
However Lam, manager of the five crown-rated Somerset Emerging Markets Dividend Growth fund, thinks there will be better value in the not too distant future.
While his cash weighting had peaked at 18 per cent last month, he doesn’t want to be fully invested at this point in time.
“The cash level is elevated owing to inflows, which we have been steadily investing over recent weeks. However, the cash level has not fallen more quickly because we aim to be careful about what particular stocks we have added to and the timings of our additions,” Lam said.
The vast majority of experts agree that while the immediate outlook for these economies looks tricky, the long-term growth story of their strong demographics and their aspiring middle classes is still very much intact.
The major argument against investing in the emerging markets, according to a number of industry commentators, is that issues such as current account deficits and currency weakness mean that the situation is likely to become worse before it gets better.
Lam agrees that there are a number of headwinds facing investors in emerging markets, including the outlook for countries that are dependent on external funding such as Brazil, South Africa and Turkey.
His biggest worry, however, is China.
“China is a particular area of concern. In China, there are bank sector problems and a risk of capital outflows,” Lam said.
“We are underweight China and the fund is not specifically exposed to its commodity imports and therefore we feel that we are relatively well placed in terms of direct exposure.”
“However, any kind of banking problems in China would certainly have a broad effect on other emerging markets and markets in general, which is something we remain acutely aware of.”
There have been a number of fund managers that have voiced concerns over the state of China’s banking system, mainly due to the rise of off-balance sheet lending from the country’s highly unregulated “shadow banking system”.
On top of that, there were short-lived liquidity crises in June and December as the SHIBOR [Chinese inter-bank lending rate] spiked, causing concerns about the health of the highly leveraged banking sector and its exposure to a booming property market.
Despite this, the likes of Aberdeen’s Devan Kaloo and Hermes’ Gary Greenberg say that the chance of an out and out financial crisis in China is still very low because the banks are well capitalised.
Lam says there is a tendency to bucket all emerging markets together, however, he says there are still decent opportunities within the sector.
“To look to the areas that may be a source of strength, Taiwan could be described as one of the brighter spots in our investable universe. It has strong export revenues and has the technology base to support its manufacturing,” he added.
Lam has managed his £506m Somerset Emerging Markets Dividend Growth fund since its launch in March 2010.
According to FE Analytics, it is the fifth-best performing portfolio in the IMA Global Emerging Markets sector over this time with returns of 14.83 per cent.
As a point of comparison, its benchmark – the MSCI Emerging Markets index – has lost 5.19 per cent over that period.
Performance of fund vs sector and index since Mar 2010
Source: FE Analytics
Lam also boasts top-quartile returns over one and three years.
However, while the fund has been one of the 10 top-performing funds in the sector over 12 months, it has still lost more than 8 per cent over this time.
Nevertheless, Somerset as a group has become increasingly popular with investors.
This is shown by the fact the boutique was forced to close its Emerging Markets Smaller Companies fund due to huge inflows.
Lam and his fellow managers at Somerset follow a rigorous bottom-up strategy, which he says helps him to outperform his peers.
“We are bottom-up stockpickers who manage a focused portfolio of around 40 Global Emerging Markets companies with growing, sustainable dividends,” he explained.
“We start with stock screens to generate ideas; we follow through with management interviews, company visits and financial modelling. We focus on minimising risks through detailed research and attention to valuation and macro risks.”
“Our analysts present their ideas to the investment team for criticism. Finally, top down macro and risk controls are put in place at the portfolio construction level,” he added.
The manager says the portfolio is more skewed towards some of the more under-populated areas of the market and is currently finding opportunities in sectors such as textiles, technology and insurance.
Somerset Emerging Markets Dividend Growth has a yield of 2.7 per cent, an ongoing charges figure (OCF) of 1.3 per cent and requires a minimum investment of £2,000.
