The two sectors have made 10.24 per cent and 7.66 per cent in the first eight-and-a-half months or so of the year – a huge contrast to their fortunes in 2013, when both struggled to break even in spite of a rallying MSCI AC World index.
The likes of Newton Global Emerging Markets, Matthews Asia Pacific Tiger and First State Asia Pacific Leaders – highlighted in an article earlier today – are among those leading the way, all returning in excess of 13 per cent.
Performance of sectors and funds in 2014
Source: FE Analytics
Sentiment turned viciously against Asia and other emerging markets in May of last year following the introduction of quantitative easing tapering and the inevitability of interest rate rises.
Poorer than expected economic data from the likes of China and Brazil, with serious worries over the former’s "shadow" banking and overheated property sectors, compounded the misery.
From 22 May 2013 to the end of the calendar year, IMA Asia Pacific ex Japan and Global Emerging Markets fell 6.93 and 6.06 per cent, respectively.
The MSCI AC World index rose 6.51 per cent over the same period.
As is often the case during market turbulence, many investors ran for the hills, with the likes of Aberdeen Emerging Markets Equity and First State Global Emerging Markets seeing inflows of close to £1bn over the past 12 months.
Again, as if often the case, many investors appear to have sold out at the wrong time.
The tide in sentiment turned in late January 2014, thanks in part to improving economic data and doubts over the pace of interest rate rises in the US, UK and Europe.
Perhaps most importantly, the pace of outflows has slowed and some value investors wary of developed market valuations even started pumping money back into funds.
FE data shows the likes of M&G Global Emerging Markets and Somerset Emerging Markets Dividend Growth have taken more than £100m in the last three months.
Asia Pacific funds have now made back their losses since May last year, and their emerging market counterparts aren’t far behind.
Performance of sectors since 1 May 2013
Source: FE Analytics
With sentiment very much on the up, it feels like there is a lot of momentum behind emerging market and Asian funds at the moment. JPM’s John Ventre believes that more money could flow into the sectors as global equity managers reduce their underweights.
Two fund of funds managers who have been proponents of investing in these cheap sectors over the past year or so are less sure, however.
Toby Ricketts (pictured), manager of the £87m Margetts Venture Strategy portfolio, has a natural bias to emerging markets, but thinks that the scale of the rally in recent months has gone too far.
In the same way investors were selling out of emerging market funds at the wrong time post the May sell-off last year, he thinks those buying into them may be disappointed.
While he doesn’t think the market will sell off significantly, he thinks much of the easy money has already been made.
“What we have seen recently is that the market is becoming driven by sentiment and short-term trends,” he said.“The sell-off in May last year was too aggressive and there were massive outflows out of emerging market and Asian funds. Investors were then taking that money and it looks like they just chucked it into US equities.”
“They then saw that emerging markets looked good value and have started to go back in. The obvious rise is now over, I think, as the market was oversold and has now bounced back.”
Ricketts doesn’t think investors can rely on sentiment alone to keep driving emerging markets higher, believing that better earnings growth needs to occur to justify further rises.
“The jury’s still out on that; not just in emerging markets and Asia, but in developed markets as well,” he said.
He adds that the weakness of sterling has amplified the returns UK investors have received from emerging market funds.
“We may start trimming our exposure following this bounce. We still think [emerging markets] will outperform over three and five years because of dynamics like growth rates and their growing middle classes. However, over the next 6 to 12 months, it’s very hard to call.”
“The point is, it was an easy decision to buy emerging markets in February and it isn’t now. The bargain has gone and though I still think they are good value, the overselling has reversed.”
Daniel Lockyer (pictured), manager of the £30m PFS Hawksmoor Distribution fund, is of a similar opinion, and has also been cutting down his exposure to emerging markets across his portfolios.
“We’ve just been banking some profit in emerging markets,” he said.“At the back end of last year we had valuation support and saw it was not very well owned in asset allocation surveys. It wasn’t really a strong view on earnings, but more a reflection of how cheap it was. With the US doing so well, we couldn’t see that emerging markets would continue to do so badly.”
“Last year it was a drag on performance, but this year it has helped. Now we think it is necessary to take into account that our portfolio is quite exposed to emerging markets, and so we have been scaling back.”
Lockyer’s Distribution and PFS Hawksmoor Vanbrugh funds have taken sizeable inflows of late. The manager says he has chosen not to top up positions in the likes of Standard Life Global Emerging Markets Income, Lazard Emerging Markets and Schroder Asian Alpha Plus, meaning the overall allocation to emerging markets has fallen.
He has actively instigated a sale of the Standard Life fund across his model portfolios though.
Lockyer’s exposure to emerging markets in the Vanbrugh fund has fallen from a high of 17 per cent in February to 13 per cent today.
He still thinks emerging markets are attractively valued, though thinks the risks of owning them have risen in the last few months.
He adds that he’s taking positions in lower beta funds such as the Standard Life fund, which tend to protect better against the downside than the MSCI Emerging Markets index.
Both Ricketts' Venture Strategy fund and Lockyer’s Distribution funds are outperforming their sector averages so far this year, thanks in no small part to their emerging market-overweights.
Ricketts’ fund underperformed last year, however, for exactly the same reason, while Lockyer’s performed in line with the IMA Mixed Investment 40%-85% Shares sector average.
Performance of funds and sectors in 2014
Source: FE Analytics
Ricketts is a top quartile performer over a 10-year period, with returns of almost 180 per cent.
PFS Hawksmoor Distribution was only launched in April 2012, but it is a top-quartile performer over that period, with returns of 34.06 per cent.
