It has paid to be selective in emerging markets over the past 12 months as while the likes of the Indian and Chinese stock markets have rallied hard, Brazil and Russia have plunged into negative territory largely as a result of falling commodity prices.
Nevertheless, more broadly the asset class has rebounded following a tough few years relative to developed as the MSCI Emerging Markets and the average IA Global Emerging Markets are fund up close to 20 per cent.
Performance of sector and index over 1yr
Source: FE Analytics
Given the dispersions in performance, the rally has by no means lifted all boats equally over the year. This is shown as although all but one of the 77 funds in the sector are in positive territory in 2015, just 6 per cent of funds have stayed ahead of index.
A number of FE Trustnet studies have highlighted that emerging markets have historically been a tough hunting ground for active managers, especially if you remove the ever-popular First State and Aberdeen funds – which now face capacity constraints as a result of their popularity – from the data.
However, some lesser-known funds have shown outperformance by pulling away from the benchmark and, over the longer term, have done so with both very high alpha generation and tracking error relative to the broader index.
Alpha is the measurement of outperformance of a benchmark, the higher the better, while tracking error measures how much a fund oscillates against its benchmark, in this case the higher the better.
Take for instance the fund with the highest alpha figure over one and three years as well being in the highest tracking error decile. The $420m Templeton Emerging Markets Smaller Companies fund, headed up by veteran manager Mark Mobius.
Launched in 2007, the fund is top of the sector over one and three years and has returned 49.4 per cent since launch - almost double the average IA Global Emerging Markets fund, according to FE Analytics. Over the same period the MSCI Emerging Markets index has gained 32.96 per cent.
Performance of fund, sector and index since 2007
Source: FE Analytics
Mobius and his team are among the most celebrated emerging market fund managers but his value investment style, according to head of research at Whitechurch Securities Ben Willis, means the fund can go through periods of underperformance.
“Value means focusing on out of favour stocks that you can buy cheaply because the market is looking at it and doesn’t like it. When you buy these you tend to find a short period of a bull market and they re-rate more quickly but when there is a lot of volatility people switch into more defensive parts of the market, he said.”
“Mobius is one of the celebrated managers and has been doing it for a long time, and that sort of experience is invaluable. If we decide to raise exposure he would be a consideration to put money into.”
While the fund’s outperformance in recent years is clear, small caps make up a much lower amount of the 4000 or so stocks in the index and so its high alpha and tracking error can partly be explained by its mandate.
In fact, the next highest scoring in terms of alpha as well as being top outperformers are the €216m Carmignac Emerging Discovery and the $400m JPM Emerging Markets Small Cap funds –which are both dedicated to small and mid-cap stocks in emerging markets.
The PFS Somerset Emerging Markets Small Cap fund, headed by FE Alpha Manager Mark Asquith, while a few rungs further down the list for the two metrics, also is [just] top decile for both and has outperformed over three and five years.
However, two funds that score highly for alpha and tracking error that invest across the cap spectrum while also being top performers in the sector are the Hermes Global Emerging Markets and McInroy & Wood Emerging Markets funds.
The two are the next highest for alpha generation, top decile for tracking error and are also ahead of sector and benchmark over one and three years in terms of total return.
Over three years, Hermes Global Emerging Markets and McInroy & Wood Emerging Markets have returned 30.74 per cent and 22.74 per cent while the sector average return is 14.56 per cent and the MSCI Emerging Markets index has gained 17.32 per cent.
Performance of funds, sector and index over 3yrs
Source: FE Analytics
Gary Greenberg, Hermes’ head of emerging markets heads up the former fund which he has managed since July 2011. The manager is very bullish on China, telling FE Trustnet last year that be backed it above any other on 30 year time horizon.
His top 10 is stuffed with China stocks such as Baidu and Tencent. In fact, only three of his 10 largest positions are listed outside of China.
Greenberg’s bullish sentiment on China has paid off with the index up more than 60 per cent over the past year
India is the managers next biggest bet with Greenberg believing the country is benefiting from a culture of economic reforms under its new prime minister Narendra Modi.
McInroy & Wood Emerging Markets has been co-managed by David Shaw Stewart, Francis Seymour and Guido Bicocchi since March 2007 and is one of the most nimble funds in the sector at £58m.
It has about 20 per cent in South and Central America, a significant overweight with many of largest positions rarer than many of the sector’s.