Focusing on quality companies with dependable earnings streams made investors a lot of money in the period following the financial crisis, but Vincent and Way believe the market has turned. They claim these sectors are expensive these days and that there are far better options available further down the market cap scale.
“There has been a quality bias in emerging markets, which has worked well but companies have become more expensive,” Vincent said. “Going forward, the style faces quite a big valuation hurdle.”
If true, their view could suggest problems are ahead for some heavy-hitting fund houses in emerging markets such as First State and Aberdeen, which tend to run their portfolios with a quality bias rather than a value one, a tactic that stood them in good stead before the recent correction.
Performance of index over 3yrs
Source: FE Analytics
FE Alpha Manager Hugh Young explained in a recent FE Trustnet interview how his style fell out of favour last year, but said the approach would prevail in the longer term.
Even with low valuations in emerging markets, Vincent and Way say investors still need to look further down the market cap spectrum to find true value opportunities.
Vincent, manager of the SLI Global Emerging Markets Equity Income fund, says he is currently finding his best non-consensus emerging markets ideas in mid caps. He adds that the reason they have managed to outperform larger companies in the sector over the past 18 months is because they are more insulated from macro factors.
“When changes aren’t priced in, that tends to take you further down the market cap [scale],” he said.
Way, who heads up the firm’s growth-oriented SLI Global Emerging Markets Equity fund, adds that investors typically take the misguided view that small- and medium-sized companies in the developing world are higher risk.
“Mid caps are not higher risk,” he said. “There’s the stereotypical view that once you go off the beaten track, you’re taking quite a big punt on things like corporate governance. But going off the beaten track into mid caps and frontier markets [is what sets us apart].”
The managers also point out that valuations are even more attractive further down the market cap scale.
Vincent admits that the last few years have been a difficult time to invest in emerging markets, but says there are a number of solid companies out there that can deliver growth over the long-term.
“In the big sell-off, our funds went down as well. But when you get big sell-offs, it’s about having the courage to say 'this is a stock we really like' and being ready to buy it,” he said.
In a previous FE Trustnet article, Hargreaves Lansdown’s Mark Dampier said cautious investors could play a potential rebound in Asia by investing in income portfolios which effectively pay investors while they wait.
The SLI managers agree that yields are attractive in Asia, but say investors do not need to seek out income-focused portfolios to benefit from attractive yields in the region.
“The great thing about yields in emerging markets is that they’re broad-based. It’s not just about utilities and telcos,” Vincent (pictured) said.
“I didn’t want the [Equity Income] fund to be a defensive fund, I wanted it to be about growth as well, because I think people invest in emerging markets for growth.”The managers do see several risks on the horizon, but they don't believe these will rock the market by as much as some people think.
The threat of a slowdown in economic growth in China and worse, a collapse of its banking sector, are possibilities, but the managers think these eventualities have been well priced in, meaning the shock of any crisis would be dampened.
They add that the banks are already owned by the Chinese government, which is well capitalised and has a solid balance sheet itself, and should be able to shore up any problems in the sector.
They also say that the country has already taken strides to prevent any sort of contagion, so it may well avoid a crisis altogether.
“People use it as a reason to dislike emerging markets overall, but a lot of the pessimism is priced in,” Way said.
Both the SLI Global Emerging Markets Equity and SLI Global Emerging Markets Equity Income funds are able to invest in some frontier market stocks, which is another area they say is under-researched in the more well-known emerging markets.
The funds have a limit of 20 per cent in frontier market stocks, but Way says they rarely have more than a 10 per cent exposure.
Both funds were launched in 2012 and have performed well relative to their peers over the short term, delivering top-quartile returns over the last 12 months.
However, as emerging markets have taken a beating, the funds have fallen as well, shedding roughly 10 per cent each over the last year. The IMA Global Emerging Markets sector fell 17.2 per cent over this period and the MSCI Emerging Markets index was down 17.5 per cent, according to FE Analytics.
Performance of funds vs sector and index over 1yr
Source: FE Analytics
The income portfolio is yielding 2.9 per cent, one of the highest figures in the sector, behind only UBS Emerging Markets Equity Income, which is yielding 5.4 per cent, Charlemagne Magna Emerging Markets Dividend, which is yielding 5.25 per cent, JPM Emerging Markets Income, with a yield of 4.94 per cent, and Newton Emerging Income, with a 4.53 per cent yield.
The SLI Global Emerging Markets Equity Income fund has ongoing charges of 0.99 per cent while the SLI Global Emerging Markets Equity fund charges 1.73 per cent.