Aberdeen has historically been seen as one the best fund groups for emerging markets and Asia Pacific ex Japan exposure, with its Emerging Markets Equity, Global Emerging Markets Smaller Companies, Asia Pacific Equity and Global Asian Smaller Companies funds all top quartile performers either since launch or over the past decade.However, their relative performance has begun to drop off recently.
According to FE Analytics, all four of those funds – which all now have an AUM figure in excess of £2bn – are bottom-quartile performers over the past 12 months.
Source: FE Analytics
Evan-Cook, who heads up various funds of funds at Premier, has recently sold his holdings in the Aberdeen portfolios.
Although the manager still rates the group’s ability and expertise, he says the funds are now so big that they can only buy the largest constituents of the index.
He says this is a problem because a lot of investors are now pulling their money out of trackers, which is causing the largest companies in the market to be hit by falling share prices.
“It all comes back to liquidity,” he said. “If you look at the emerging markets and Asia – the latter in particular – the small cap index has been relatively unscathed this year while the large cap index has been hit very hard. This has been particularly problematic for the likes of Aberdeen.”
Performance of indices in 2014
Source: FE Analytics
“People have been diving into these sorts of funds but they have also been diving into trackers that track high cash-flow emerging markets stocks.”
“All of a sudden, when that changes and snaps, then that hits the largest constituents of the index.”
Emerging markets and Asia Pacific ex Japan funds have all had a tough time of it recently as investors have become increasingly concerned about issues such as an economic slowdown in China, the impact of the Fed’s QE tapering and currency weakness.
However, Evan-Cook says that Aberdeen has been hit particularly hard because, due to the size of its funds, it has been at the mercy of ETF outflows.
“Liquidity can be your friend over the long-term, but it is actually turning into your enemy at the moment,” he said.
“A lot of the index constituent stocks, which the ETFs can buy, had been driven up massively. This was one of the reasons why we bought into frontier markets a few years ago because not only were they cheap, they were too small to be affected by ETFs.”
His thoughts echo those of Toby Ricketts, who told FE Trustnet last year that tracker funds can cause a “self-ponzification” effect whereby the largest companies in the index keep getting bigger as more money goes in.
Aberdeen has recognised that some of its funds have reached capacity, which is why it soft-closed its emerging markets portfolios last year.
Nevertheless, the Aberdeen Asia Pacific Equity and Global Asian Smaller Companies funds are still open to new money.
A spokesperson for Aberdeen countered Evan-Cook's argument by pointing out that some 20 per cent of the portfolios' assets are invested in non-benchmark stocks.
FE Alpha Manager Hugh Young, head of global equities at Aberdeen, recently told FE Trustnet that the underperformance of its funds was due to the strong performance of lower quality areas of the market.
Young also said that while Aberdeen’s focus on quality companies with reliable earnings has hit performance in the short-term, those companies will inevitably outperform over the long-run like they have done in the past.
Evan-Cook agrees that their style hasn’t helped performance recently, but he says it is dangerous to assume that just because one area of the market has been shown to have made investors money in the past, it will do so again the future.
For example, the manager recently told FE Trustnet that he was concerned about the stampede of money heading into UK small caps.
He says one of the reasons why people are now buying more and more smaller companies funds is because research has shown they have beaten large caps over nearly all time frames.
Evan-Cook says that, like the belief that small caps will always outperform large caps, it is wrong to believe that quality emerging markets stocks will always outperform the value end of the index.
“The trouble is that the more studies that are done, the more people think that it is easy to make money,” he said.
“That’s when you get to the point when they have become so overvalued that it becomes a bad time to own them. I guess it’s like the Aberdeen effect.”
“It’s a similar thing where emerging market quality has shown to be such a winner over all time periods that everyone piles into it. As soon as everyone spots that, then that is the time to be concerned.”
“It’s a sign of how the market works. If something works for a long time, people cotton onto it and it becomes more popular. When that happens, it becomes divorced from fundamentals and the original case for owning it becomes destroyed by valuations.”
There are a number of managers who agree with Evan-Cook’s assessment on this point – one of whom is Jonathan Pines.
His Hermes Asia ex Japan fund, with its value approach, has been the best performing portfolio in the IMA Asia Pacific ex Japan sector over one year.
Pines told FE Trustnet last year that the search for quality in emerging markets had inflated a bubble in the sector's traditionally defensive sectors.
While Evan-Cook says that quality stocks have in general underperformed, he says Aberdeen has struggled in particular because of the amount of money it is running.
“Aberdeen has had the effect of their style reversing a bit, plus how stuck they are in certain stocks,” Evan-Cook said.
“We still own emerging market quality funds and they haven’t done as badly as Aberdeen. That is because they have been able to find hiding places, for instance investing in good quality stocks which don’t make up large parts of the index.”
“FF Fast Emerging Markets, which is what we replaced our Aberdeen exposure with, has also got a quality focus. However, it had a cracking year last year because the manager has been able to move around, plus he can short, which helps.”
Performance of funds vs index in 2013
Source: FE Analytics
Our data shows that the FF FAST Emerging Markets fund – which is managed by Nick Price – returned 16.46 per cent last year while the MSCI Emerging Markets index returned 3 per cent and the Aberdeen Emerging Markets Equity fund lost 9.5 per cent.
