Though they were some of the most popular funds during the boom years before the financial crisis, global emerging market portfolios have been through quite a prolonged period of underperformance relative to the likes of the UK and US.
According to FE Analytics, the MSCI Emerging Markets index has returned just 11.43 per cent over five years while, on the other hand, the FTSE All Share is up 49.26 per cent and the S&P 500 has gained 94.54 per cent.
Performance of indices over 5yrs
Source: FE Analytics
However, while they witnessed a mini-renaissance last year and are up 7 per cent in 2015, Katy Thorneycroft – manager of various funds of investment trusts at JPM – says that now is a time for investors to be selling down their emerging market exposure.
“We have been underweight emerging markets and we have become even more cautious recently,” Thorneycroft said.
“While they have underperformed relative to developed markets, when you look previous times when they have underperformed, this isn’t exceptional and during past experiences that underperformance has continued for some time.”
“Yes, there are certain Asian markets – such as India and China – which will benefit from the lower oil price, but when you look on aggregate a number of global emerging markets economies are energy producers.”
The recent fall in the oil price – it is down 40 per cent over the past 12 months – is expected to effectively act as a tax break for certain economies as consumers and corporations won’t have to spend as much on fuel.
However, the fall in the oil price has had a very negative impact on some of major constituents of the emerging markets index, such as Brazil, Russia and Nigeria.
Performance of indices over 1yr
Source: FE Analytics
It wasn’t just the major commodity producing developing economies that were hit, as the likes of Turkey and South Africa saw significant currency weakness during the major falls in December.
Mark Burgess, chief investment officer at Columbia Threadneedle Investments, agrees that while emerging markets look optically cheap, equity markets will come under pressure from the lower oil price, which at the time of writing, stands at $55 a barrel.
“Emerging market equities trade at a significant discount to developed markets and there are good opportunities in the countries that are beneficiaries of lower oil prices and where the respective governments have committed to business-friendly reforms,” Burgess said.
“Unfortunately, commodity-exporting emerging markets, such as Brazil, remain under pressure and similarly the low oil price is a headache for a range of emerging markets oil exporters with knock-on adverse effects for their currencies.”
The other reason why Thorneycroft is negative on emerging markets is due to the US’s improving economic story.
The US has been the leading developed world economy following the financial crisis.
Though the dollar weakened relative to sterling last year, it has strengthened significantly over the last six months and the consensual view is that this will continue as the US Federal Reserve tightens monetary policy further.
The Fed’s first rate hike is expected later this year and Thorneycroft says this will be bad news for emerging markets as many of those countries’ debt is issued in dollars.
“Also, we expect that as we see the US dollar strengthen and we see the US Federal Reserve start to raise interest rates, it will have negative impact on emerging markets,” Thorneycroft said.
Though Thorneycroft is negative on emerging markets, she is positive on US equities – despite their stellar gains over recent years.
Our data shows the S&P 500 has returned a hefty 215.35 per cent since it bottomed after the financial crisis in March 2009 and has had a maximum drawdown, which measures the most an investor would have lost if they had bought and sold at the worst possible times, of just 18 per cent.
Performance of indices since March 2009
Source: FE Analytics
It is also the only major developed market index to deliver a positive return in each of the last six calendar years, according to FE Analytics.
This has led many experts to avoid the US altogether. Kennox’s FE Alpha Manager Geoff Legg, for example, described it as a market long-term investors should avoid at all cost as the current high valuations on offer mean the index will materially underperform from here.
Legg says there have been a number of reasons why the US has performed so strongly – such as mass central bank intervention and huge amounts of share buybacks from company management teams – which have pushed the market to artificially high levels.
“Add into this mix the depreciation of gold and ongoing uncertainty in other regions – notably Europe and Japan –the perfect environment for an overheated US equities market has developed,” Legg said.
He added: “This is an area to avoid for investors with long-term horizons.”
However, Thorneycroft says that while the US is not exactly cheap, economic growth will translate into better corporate earnings. Also given that central banks, such as the ECB and the Bank of Japan, are still pumping liquidity into the bond market, the manager believes demand for US equities will remain strong.
In terms of her US exposure, Thorneycroft uses the likes of JPM American IT and then more esoteric portfolios such as the Worldwide Healthcare Trust and the Biotech Growth trust – which both have high levels of exposure to North America.
Her only global emerging markets holding is Dr Mark Mobius’ Templeton Emerging Markets IT, which has gone through a period of underperformance of late due to the manager’s value bias.
However, one trust she likes which can give exposure to both innovative US companies and pockets of value opportunities within emerging markets is Scottish Mortgage IT, which is headed-up by the long-serving James Anderson and is Thorneycroft’s third largest holding in her £330m JPM Multi Manager Growth fund.
Anderson holds 38 per cent in the US and around 25 per cent across emerging markets, while his top 10 positions include the likes of Amazon, Google and Facebook along with Asian stocks such as Baidu, Tencent and Alibaba.
Our data shows Scottish Mortgage has been the best performing IT Global trust over 10 years with returns of 387.66 per cent, beating its benchmark – the FTSE All World index – by 130 percentage points in the process.
Performance of trust versus sector and index over 10yrs
Source: FE Analytics
It is the second best performing global trust over five years and once again top of the sector table over one and three years. It must be noted that the closed-ended fund has tended to fall further than its peers during periods of market weakness.
It is also trading on a 1.76 per cent premium to NAV due to that performance. Scottish Mortgage is geared at 13 per cent and has ongoing charges of 0.5 per cent.