Global equity funds have a tendency to avoid emerging markets, with the average IA Global fund holding 42 per cent of assets in the US, 13 per cent in Europe and 11per cent in the UK. 
In fact, according to data from FE Analytics, less than one-third of the 309 funds in the IA Global and IA Global Equity Income sectors have any significant exposure to emerging market equities.
This is might be unsurprising, particularly from a current macroeconomic perspective. Falling commodity prices have stung the likes of Brazil and Russia, while fears of a potential Indian correction loom on the horizon following a rallying market.
However, many investors buy a global fund to diversify away from core UK holdings and may expect to get truly worldwide exposure. Are they being let down by ‘global’ funds that only focus on developed markets?
One explanation is the very nature of benchmarks. The MSCI World, one of the most common benchmarks for the sector, has a 57.57 allocation to US, explaining why the country is consistently the biggest position in a global fund.
Adrian Lowcock (pictured), head of investing at AXA Wealth, said: “To be in line with [global] exposure, you wouldn’t necessarily hold a high weighting in emerging markets. Emerging markets consist of a relatively small amount of the global stock markets – if you’re going globally, the US still continues to dominate.”
“Then you add in markets like the UK, European markets, Japanese markets, and you get a large portion of the stock market’s wealth and market cap valuations in the west.”
Other factors may also be at play. Lowcock said: “It could be to do with the current outlook on emerging markets and the nervousness around that. Following the financial crisis, you had this hot potato of problems being passed onto the US, to Europe and the emerging markets, and the outlook for emerging markets deteriorated around 18 months ago.”
“What happened was they did quite well and they were no longer cheap. You’re paying premiums for effectively the economic growth, whereas western developed market companies still have exposure to those markets through their own business operations, but you would perhaps have better regulation and business management.”
“However, emerging markets equivalents were trading at a higher premium, so that valuation had to reverse to put emerging markets where they perhaps naturally sit, which is at a discount relative to more developed markets because there are bigger risks.”
Not only is there apprehension surrounding emerging markets, there are also plenty of reasons why investors are bullish on developed markets at the moment.
Quantitative easing (QE) in Europe and Japan, fairly strong earnings and low interest rates in the US and the UK, and the weak euro giving support to European exporters are all substantial pull-factors for many investors.
However, if an investor chooses to put their cash into a global equity fund, is it really fair that entire markets are being left out?
Some global fund managers, including Lazard’s Pat Ryan, are seeing a lot of potential in emerging market stocks and believe other managers are missing a trick.
Despite currently holding his biggest positions in US and European equities, Lazard Global Equity Income has a 12 per cent weighting in Asia Pacific emerging equities, 4.3 per cent in Latin American equities and 1.6 per cent in Africa – all overweights.
Ryan’s top-10 holdings include two Taiwanese companies – Taiwan Semiconductor Manufacturing and Siliconware Precision Industries Co, which also focuses on semiconductors. Also included in the list is the Agricultural Bank of China.
“We’re finding budding opportunities in stocks that are a little less well-known, that are domiciled in places that are perhaps perceived to be less safe than the US and the UK, and as well as things that are slightly more cyclical,” he said.
“It’s specific areas within global financials that we’re particularly excited about. Our most prominent and perhaps most controversial is the emerging market banks – China predominantly within that.”
“We broadly feel that people are too negative on the Chinese economy and their financial stability. We do concede there are clear issues but this government has over a trillion dollars in foreign currency reserves to address those issues – the banks are very well-capitalised.”
“They’ve gone up a lot recently. There’s a lot of excitement about the rally in China and people are talking about bubbles. Yes, our banks have gone up 30 per cent in the past few months and it’s gone all the way from 5x earnings to 6.5x earnings – but that still looks pretty cheap to me.”
Other funds in the IA Global sector have a higher weighting to emerging markets. SKAGEN KonTiki, which focuses on the asset class, holds a substantial 47.6 per cent weighting in Asia Pacific, 7.7 per cent in emerging European, 6.2 per cent in emerging American and 5.9 per cent in global emerging market equities.
Co-manager Kristoffer Stensrud and his team look for low-priced, high-quality companies that are unloved or under-researched in order to provide the best possible risk-adjusted return.
This approach has arguably worked, as the fund has produced a top-decile Sharpe ratio of 0.46 per cent over a 10-year period, which is 0.15 percentage points more than its average peer.
The LO Funds Emerging Consumer fund has a 38.5 per cent weighting in emerging Asia Pacific equities.
The fund, which is managed by a team of four, has had a disappointing performance over one and three years, sitting in the bottom decile. However, this has coincided with period of generally weak returns for emerging market equities.
Performance of fund vs sector and index
Source: FE Analytics
Sanlam Global Financial, co-managed by Kokkie Kooyman and the Sanlam Asset Management team, is 47 per cent invested in emerging markets, the largest exposure being in India and Indonesia. It is the global fund with the highest exposure to emerging Europe, at 15 per cent of assets.
The management team invests in financial companies from around the world with an aim to provide long-term capital growth. As a general rule, they only invest in stocks that they believe to be mispriced.
This method has provided the fund with top-decile total returns of 157.65 per cent over 10 years, which is 33.84 percentage points more than its peer average.
Old Mutual Global Best Ideas, managed by Lee Freeman-Shor, has the highest weighting to Latin American equities within the IA Global sector at 32 per cent. However, this is the only emerging asset class that the fund is invested in – its biggest position is in European equities at over 40 per cent.
The fund has performed well over five years, achieving top-decile returns of 60.18 per cent, which is 9.17 percentage points more than its sector average.
Performance of fund vs sector over 5yrs
Source: FE Analytics
However, Old Mutual Global Best Ideas has underperformed its peers over a three-year period by three percentage points, placing its performance in the bottom decile.
The fund with the highest allocation to global emerging equities at 82.6 per cent is the five FE Crown-rated FP Octopus Global Growth fund, co-managed by Bish Limbu, Colin Lunnon and Simon Reynolds.
Despite providing almost half the returns of its sector average since its launch in 2011, the fund has achieved top-decile performances over the past year.
Performance of fund vs sector since launch
Source: FE Analytics
Should investors be actively seeking these funds that have a higher weighting, or at least some weighting, in emerging markets?
Lowcock believes that you cannot judge the credibility of a global fund based on its asset allocations.
“For a global fund, you’re looking for a manager which has a particular type of philosophy when it comes to investing globally,” he said. “For example, the Lindsell Train guys adopt a buy-and-hold process, so they’re looking at businesses which can evolve and that are going to be around a long time.”
“With a manager like that, you’re not buying them to have an exposure to emerging markets - you’re buying them for their global strategy. From an investor point of view, that’s how I would buy a global fund.”
