Emerging market funds have considerably underperformed against their developed market rivals over recent years as investors have been concerned about slowing economic growth, the impact of QE tapering and other macroeconomic headwinds.
However, there are tentative signs that developing world equities may have bottomed with the MSCI Emerging Markets index delivering a return of 3.6 per cent since over the last month compared to the S&P 500’s loss of 0.63 per cent.
Performance of indices over 1 month
Source: FE Analytics
While there are concerns that this is nothing more than a dead-cat bounce, for those higher-risk investors who want to add to their exposure for the long term, we ask the experts what are the main characteristics they look for when deciding on which emerging market fund to buy.
Actively managed
Simon Evan-Cook (pictured), senior investment manager at Premier, says it is important that investors focus on funds that aren’t simply tracking the index.
“What we look for in a fund hasn’t changed because we are always looking for a genuinely active manager who is concentrating on investment fundamentals instead of just chasing stories,” Evan-Cook said. Mike Deverell, investment manager at Equilibrium Asset Management and member of the AFI panel, agrees that investors should be taking the active route over a passive one.
“We have been looking at emerging markets closely, but historically we have used the Vanguard Tracker fund as our research showed us that very active few funds had consistently beaten the index,” Deverell said. “That seems to be changing, however.”
“We now want funds that are totally benchmark agnostic with a bottom-up value approach. There are now more value dispersions than there have been in the past, for instance the index as whole has a P/E of 10 times, but areas such as China are considerably cheaper.”
While he hasn’t made his final decision, Deverell says he is eying up the Skagen Kon-Tiki fund for that active approach.
According to FE Analytics, the Norwegian-domiciled fund has beaten its MSCI Emerging Markets benchmark in nine out of the last 10 discrete calendar years, the exception being in in 2012 when it underperformed by 5 percentage points.
The now £5.7bn has also been top quartile in terms of its alpha generation relative to its benchmark, its information ratio and Sharpe ratio over a cumulative ten year period.
Nimble size
However, while Evan-Cook says that going down the active route is important, he says genuinely active funds cannot be constrained by size. Because of that, the manager focuses on funds that have smaller AUM.
“We are still very keen on finding funds that are manageable in terms of size. For us, it is clear that some of the biggest funds in the sector aren’t and just don’t have the flexibility to move the portfolio anymore,” Evan-Cook said.
Evan-Cook has warned about the impact size can have on performance, especially in emerging markets as he says larger funds are forced to buy the biggest and most liquid constituents of the index and are therefore at the mercy of large-scale ETF money.
Two of his favourite active and nimble funds are the five crown rated £135m Charlemagne Magna Emerging Markets Dividend fund and the $434m Hermes Asia ex Japan fund.
Our data shows that both have considerably outperformed their respective sectors and benchmarks since they were launched.
For instance, Jonathan Pines’ Hermes fund, which came into the IMA universe in October 2012, has been the best performing portfolio in the IMA Asia Pacific ex Japan sector over that time and has more than quadrupled its benchmark’s return in the process.
Performance of fund versus sector and index since October 2012
Source: FE Analytics
The five crown rated Charlemagne Magna Emerging Market Dividend fund, which is managed by Julian Mayo and has a yield of 5 per cent, has been the sixth best performing IMA Global Emerging Markets fund since its launch in June 2010 with returns of 23.72 per cent.
Small & mid-cap exposure
Ben Willis, head of research at Whitechurch, says that if higher-risk investors want to find areas of the markets that would benefit from a more positive sentiment, they should look to funds that have a high weighting to small and mid-cap stocks.
“We think now is a good entry point into emerging markets, but if we want exposure then we want to be going down the mid and small cap route,” Willis said.
“We don’t know what the catalyst for change will be, but emerging market valuations, in general, are not only cheap compared to developed markets but also compared to their history. When that turns, it will be small and mid-caps where you will get the most accelerated growth.”
While there are number of funds in both the IMA Global Emerging Markets and IMA Asia Pacific ex Japan that can invest across the market cap spectrum, there are a select few portfolios which only invest in mid and small-caps.
Aberdeen have tended to be the leading light in the sector with their Global Asian Smaller Companies and Global Emerging Markets Smaller Companies funds, though both are now multi billion pound portfolios.
Other alternatives include JOHCM Asia ex Japan Small and Mid-Cap, Matthews Asia Small Companies and JPM Emerging Markets Small Cap – all of which have outperformed their peers, and the market, since they were a launched.
For instance, Cho Yu Kooi’s £13.8m JOHCM Asia ex Japan Small and Mid-Cap fund was launched in September 2011.
Performance of fund versus sector and index since September 2011
Source: FE Analytics
Over that time it has been a top quartile performer in the sector and has beaten its MSCI AC Asia ex Japan Small Cap benchmark with its returns of 30.91 per cent.
It was however, as the graph above shows, hit particularly hard following Fed chairman Ben Bernanke’s speech regarding the tapering of QE in May last year, meaning the fund has lost more than 10 per cent over 12 months.