While one major reason for the negative investor sentiment has been the economic slowdown in China and other developing markets, the tightening of the Fed’s monetary policy has also had a detrimental effect.
Talk of QE tapering led investors to cut their emerging markets exposure, opening up concerns about currency weakness and the so-called fragile five’s (Brazil, India, South Africa, Indonesia and Turkey) need for external funding due to current account deficits.
While the underperformance of emerging market equities has been a noticeable theme over recent years, fears over tapering and geo-political risk in Ukraine have made it even more prominent over the past 12 months.
Performance of indices over 1yr
Source: FE Analytics
However, with valuations now extremely low in the developing world while the UK and US markets are looking expensive, a number of fund managers – such as Unicorn’s Peter Walls – have been buying up emerging market equities because they believe in its long-term growth story.
Tom Becket (pictured), chief investment officer at Psigma, is also weighing up buying into emerging markets.
However, he says that if investors were to buy in now, they could be hit by immediate losses.“We haven’t made a decision yet, but it seems the time appears to be getting closer and closer as the S&P keeps breaking its record on an almost daily basis and emerging market equities continue to fall,” he said.
“It does feel that that long-term change is very close, but in truth, it isn’t now. I still think there is the chance of a significant correction in global equity markets, which I don’t think emerging markets will be able to avoid, even though the majority of investors are underweight them.”
FE Alpha Manager Martin Gray, who runs the CF Miton Special Situations Portfolio, agrees with Becket.
The manager is very bearish on the majority of asset classes and warned FE Trustnet last month that there is very little value anywhere.
Despite this, he says that emerging markets are looking increasingly attractive but says it is too early to buy into them now.
“We are looking into emerging markets, but I would still want them to fall a bit further,” he said.
“While those stock markets have still come back a long way, I am still nervous about some of those currencies. We have favoured south-east Asia in the past and we think it is a good long-term play and it is looking interesting again.”
“However, while they are bombed out, I think that there is a bit more selling still to come. We haven’t got any real exposure at the moment, but I am always open to new ideas. However, we have to see an upside and as I said, I’m still worried about those currencies.”
Jan Dehn (pictured), head of research at Ashmore, says that the pessimism towards the emerging economies is turning increasingly hysterical.
He says that the fragile five should now be called the frugal five because they have taken steps to protect themselves by raising interest rates and adjusting their currencies. Some of them have also undertaken major fiscal adjustments.
“Countries do not have to be perfect to warrant investment: they just have to be better than what is priced in and what is available elsewhere,” Dehn said.
“The sooner investors get their heads around the fact that as a whole the 65-strong emerging market countries are generally healthy – including the frugal five – the sooner they will see that emerging markets are precisely that, better than what is priced in and better than what is available elsewhere.”
Brian Dennehy, managing director at Dennehy Weller & Co, thinks that there are now good opportunities in emerging market equities and says investors can afford to up their exposure, albeit very carefully.
“There is good value in emerging markets, but the big 2014 problem is overvaluation in the US plus tapering – both are negative for all global equity markets. So buy emerging markets by all means, but do so cautiously, for example dripping in over the next 12 to 24 months,” Dennehy said.
Drip-feeding, or investing smaller amounts on a regular basis, is a useful tool for playing a possible recovery in an asset class as it means investors benefit from pound/cost averaging, which means that they will be buying more units when markets fall and less when they rise.
While they may not capture as much upside in a rally, it means they don’t lose as much if markets tank.
Dennehy recommends the Baillie Gifford Emerging Markets Leading Companies fund – which is managed by Will Sutcliffe – for anyone who is considering drip-feeding.
The £410m fund has made 9.42 per cent since he started managing it in January 2010, slightly outperforming both the MSCI Emerging Markets index and the IMA Global Emerging Markets sector, which have returned 8.64 per cent and 8.16 per cent, respectively.
Performance of fund vs sector and index since Jan 2010
Source: FE Analytics
The fund is a top-quartile performer over 12 months as it has protected capital more effectively than the sector average and the index. However, it has still lost 8.94 per cent over this time.
It is a concentrated portfolio that tends to focus on larger and more liquid names.
South Korea is the manager’s largest regional weighting, though he also has decent exposure to China, Taiwan and India.
The fund has an ongoing charges figure (OCF) of 1.61 per cent. It requires a minimum investment of £1,000 and its minimum top-up amount is £100.
