It is a part of the market that has rebounded this year on the back of attractive valuations.
However, a recent FE Trustnet study showed that only a third of funds had managed to beat the MSCI Emerging Markets index over the last five years.
Worse than that, if you were to remove the highly popular but now closed First State and Aberdeen funds – which have historically been investors’ go-to portfolios for emerging market exposure and account for nearly half of the sector’s assets – only 24 per cent have beaten the index.
There have been some notable exceptions, of course.
The five crown-rated McInroy & Wood Emerging Markets fund, which is completely benchmark agnostic, has been the best performing non-Aberdeen or First State fund in the sector and has more than doubled the return of the index over five years with returns of 54.97 per cent.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
Unfortunately, however, the £56m fund is not widely accessible to retail investors as it is only available on select number of platforms.
Then there is Lazard Emerging Markets, which is managed by the long-serving James Donald.
With returns of 30 per cent, it has only slightly outperformed its benchmark over the last half decade, but it is the only portfolio in the sector to beat the index in each of the last five calendar years.
Nevertheless, professional and private investors have been put in a difficult position.
High-profile managers such as First State’s Angus Tulloch and Jonathan Asante have warned that, due to globalisation, emerging markets are no longer the high growth areas that they used to be 10 to 15 years ago.
Given that the underlying quality of available managers in the sector doesn’t look that great and as previously strong economic growth is unlikely to be repeated, is there still a case for holding funds in the IMA Global Emerging Markets sector?
“It’s something we are reviewing at the moment, but we haven’t found the optimum solution yet,” FE Alpha Manager David Coombs, head of multi asset at Rathbones, (pictured) said.
“I’m slightly frustrated by the fact that the emerging market index is now just a lot of large-cap stocks and is completely different to what it was 25 years ago. We are wondering what does emerging markets mean anymore and do we really care about the IMA sector or the benchmark?”
Coombs says investors need a far more tactical strategy than they used to have and therefore takes a different approach to emerging markets than most other managers as a result.
“We agree that there isn’t that many very good global emerging market funds out there,” Coombs said.
He uses a core and satellite approach within his Rathbone Multi Asset Enhanced Growth Portfolio.
For is core exposure Coombs uses the Oppenheimer Developing Markets fund, which sits in the offshore universe.
He has a legacy holding in the closed First State Asia Pacific Leaders fund and he also uses the Genesis Emerging Markets Investment Trust as he thinks all three have the ability to outperform.
While those portfolios give him a good spread, Coombs then looks to add value by using regional emerging market investment trusts.
The FE Alpha Manager added: “If you want regional opportunities, then investment trust land is the place to be.”
In the past Coombs has used trusts that have focused on the ASEAN region and has also held Aberdeen New Thai when it was trading on an attractive discount. However, his current value play is the Baring Emerging Europe trust.
The trust, which is managed Matthias Siller, has seen its discount widen as investors have become increasingly concerned about the ramifications of the crisis in Ukraine and the related tensions between Russia and the West.
According to FE Analytics the closed-ended fund, which has 54.4 per cent in Russia, has fallen 17 per cent this year due to poor NAV performance and a widening discount.
However, its MSCI Emerging Europe 10/40 benchmark has also seen double digit losses.
Performance of trust vs index in 2014
Source: FE Analytics
The manager says he isn’t buying the trust on the back of a macro call, but it is more to do with the fact that the market is “ridiculously cheap”.
This strategy is not too dissimilar to the one implemented by Chris Metcalfe, investment director at IBOSS, who is also concerned about the lack of quality active managers in the sector.
He uses the five crown-rated Somerset Emerging Markets Dividend Growth fund, which is run by FE Alpha Manager Ed Lam and wasn’t included in our recent study as it doesn’t have a five-year track record.
Launched in March 2010, it has been the sixth best performing portfolio in the IMA Global Emerging Markets sector with returns of 24.85 per cent.
The MSCI Emerging Markets index, on the other hand, has returned 3.19 per cent.
The reasons why Metcalfe has used the fund instead of others in the sector is because, as a house, Somerset only invest in emerging markets and therefore have to “live and die” by their decisions.
“Emerging markets is what they do and if they underperform, we know that it isn’t down to a lack of concentration,” Metcalfe (pictured) said.
Like Coombs, however, Metcalfe is taking more tactical exposure via FE Alpha Manager Nick Price’s five crown-rated Fidelity Emerging Europe Middle East and Africa fund.“It is a long-term holding for us,” Metcalfe said.
“There are obviously short-term issues such as currency headwinds, but those come with the territory. When you think of high growth areas of the world, then Africa is right up there for us.”
Metcalfe says he chose Price’s £142m fund over others because of the manager, Fidelity’s resources and the amount of people the group has “on the ground” in a part of the market which is under-analysed. All that combined, he thinks the fund can add value.
The fund, which sits in the IMA Specialist sector, was launched in January 2008 and has returned 38.9 per cent over that time.
As a point of comparison, the MSCI EM EMA index has lost money over the period.
Performance of fund vs index since Jan 2008
Source: FE Analytics
Mike Deverell, investment manager at Equilibrium, sees no issue with using broad-based emerging market funds for his exposure.
However, he says that as there are next to no managers in the sector that have demonstrated an ability to outperform on a consistent basis, he simply uses the $7.8bn Vanguard Emerging Markets Stock Index fund across his clients’ portfolios.
It certainly seems like an attractive alternative as it has an ongoing charges figure (OCF) of 0.27 per cent, has outperformed most active funds since its launch in June 2009 and has had a tracking error of just 0.5 per cent over that time.
Despite that, Deverell told FE Trustnet that as there are growing deviations in performance between the different emerging markets, he is contemplating using active funds again.
He isn’t necessarily looking in the IMA sector, however, as he favours the £5.4bn Skagen KonTiki fund.
The portfolio is benchmarked against the MSCI Emerging Markets index, but as the managers like to hold developed market companies that derive their earnings from emerging markets, it sits in the more flexible IMA Global sector.
Our data shows it has beaten the index in nine out of the last 10 discrete calendar years.
Over a 10 year period, the fund has returned 319.36 per cent; which is more than 130 percentage points more than the index’s gain.
