Emerging market equities have vastly underperformed against the likes of the FTSE All Share and S&P 500 over recent years.
Performance of indices over 1yr
Source: FE Analytics
Initial concerns towards the emerging markets among investors began with slowing economic growth in countries such as China.
However, the possible impact of the Fed’s QE tapering has compounded that negative sentiment and pushed the MSCI Emerging Markets index lower and lower. Ricketts (pictured), who heads up a number of funds of funds at Margetts, has been a long-term emerging markets bull and his portfolio positioning has reflected that view for the last decade or so.
The vast underperformance of emerging markets funds has hurt Ricketts' returns and while he admits with hindsight that having such a weighting was a mistake over the last 18 months, he has been buying more of the likes of Somerset Emerging Markets Dividend Growth and Schroder Asian Income as he says it is only a matter of time until their value is recognised.
“It got very painful last December and we thought a lot about whether we want to carry on with our position,” he said.
“There are concerns about a possible debt-driven crisis in China, but if you look at valuations, they are at post-crash levels in emerging markets, while developed markets, such as the US, have moved above their historic levels.”
“The question is, do you go for the market where sentiment is really poor and valuations are cheap or do you go for very positive sentiment and expensive valuations? We think sentiment will turn in favour of emerging markets and we have been adding to our exposure.”
According to FE Analytics, Ricketts’ £83.7m Margetts Venture Strategy fund – which has always tended to have a high weighting to global emerging markets and Asia Pacific funds – has been the second best performing portfolio in the IMA Flexible Investment sector over 10 years with returns of 145.49 per cent.
Performance of fund vs sector over 10yrs
Source: FE Analytics
It has beaten the sector in eight of the last 10 discrete calendar years as well. However, it has been a bottom quartile performer over one and three years due to its poor relative performance in 2011, 2013 and so far in 2014.
The portfolio’s 60 per cent exposure to emerging markets and Asia Pacific has stayed relatively constant over that time with First State Global Emerging Markets Leaders, Fidelity Emerging Markets, Aberdeen Asia Pacific Equity, Aberdeen Emerging Markets Equity, Somerset Emerging Markets Dividend Growth, Schroder Asian Income, Newton Asian Income and First State Asia Pacific Leaders all featuring in his current list of top 10 holdings.
Ricketts admits it was a mistake to have such a high weighting as he didn’t foresee Ben Bernanke’s initial talk of tapering having such a negative effect. However, he isn’t going to give up on his exposure.
“It’s a tricky one. Given the information we had at the time it didn’t feel like a mistake, but it looks like one, because of course it has hurt performance,” he said.
“However, we like to invest in underowned areas of the market and wait for that value to be realised. With a value approach, you can have some bad years, but I think it eventually delivers better performance with lower risk. I’m glad we didn’t change our mind and just go with the momentum trade.”
The manager applauds those who called the developed market recovery, though he says people who are buying into US and UK equities now in the expectation that they will repeat their recent stellar returns need to re-evaluate as company earnings need to catch up with equity ratings.
Performance of indices over 5yrs
Source: FE Analytics
While a number of experts are steering well clear of the developing world, there have been a number of managers, such as Psigma’s Tom Becket and FE Alpha Manager Martin Gray, who are waiting for emerging market equities to fall in the near term before they buy into the market. Ricketts says that both those schools of thought are misguided.
“There are a lot of people talking up the contrarian approach but aren’t actually doing anything,” Ricketts said. “We don’t do that, though I’m not saying it always works as it isn’t working at the moment.”
“However, though it isn’t at the same extent as the tech bubble, there are echoes of it in the developed markets. In the US for instance, we are seeing great performance of stocks where it’s hard to see where the earnings or value is coming from.”
“Facebook is on 100 times earnings and I think a lot of managers are buying it just because it is a large stock. One answer from a US manager as to why he held it was because 'there is only one Facebook'. That is not a good answer.”
The manager says there has been a tendency for investors to have “blind faith” towards the likes of the US and UK equities and expects returns from those markets to be broadly flat over the next 12 months as earnings growth needs to be very strong to justify current P/E ratios.
Because of that, the manager expects investors to realise the good value opportunity from emerging market equities sooner rather than later.
“As I said earlier, I hear the contrarian story a lot but people are just waiting for others to move first,” he said. “People who take the first step may look foolish initially, but they get the highest reward.”
The manager admits that there are still headwinds facing the developing world, but he says negative sentiment has swung too far.
For instance, while he admits that the financial system in China needs to be ironed out, he says the investors are wrong to believe that a crisis will be triggered as crises are caused by unknown events.
“You’ve got valuations in Asia back at 2009 levels, however, we are supposed to be getting this apparent crisis. It is not going to be as severe as the market is pricing in, it never is, and that is when you get your upside,” he said.
Margetts Venture Strategy has a minimum investment of £1,000 and its clean share class has an ongoing charges figure (OCF) of 1.75 per cent.
