Investors should overweight emerging market equities due to an imminent upswing in global growth and low valuations, according to fund managers at Barclays Capital, who have recently moved from a neutral to overweight position in their global equity strategy.
Emerging market stocks have had a precarious three years due to nasty falls in 2013 with three notable double-digit corrections taking place in the wake of the taper tantrum, but they have gradually ground higher.
The MSCI Emerging Market index and the IA Global Emerging Market sector average are up 15.96 per cent and 12.94 per cent respectively over three years, according to FE Analytics.
Performance of sector and index over 3yrs
Source: FE Analytics
The portfolio team at Barclays Capital believes emerging markets are attractive due their recent falls as well as their relative price to other equity markets. They have reduced exposure to Asia Pacific ex Japan as well as taking profits in Japanese equities to fund the portfolio shift.
“We are increasing our recommended weighting in emerging markets within our global recommended portfolio, from a previously neutral 9.8 per cent weight to an overweight 17.8 per cent. Emerging market equities have suffered from poor demand trends in developed markets, which have hampered their exports and earnings. An expected quickening in global growth in the second half of the year should help reverse this,” the team said.
“Emerging market equities now offer a higher implied risk premium than developed market equities – a situation that has preceded outperformance in the past, while international investors have been exiting; suggesting sentiment is now negative.”
“Within emerging markets, as with developed markets, defensive sectors are richly priced while financials and cyclicals are not. In particular, emerging market banks have been heavily de-rated versus the wider emerging market universe but also relative to developed market banks.”
The team have bought Akbank, PKO, Shinhan Financial Group and Cemex while selling Daiwa House, Mitsui Chemicals, Toyota and Kraft.
Emerging market equities have found decreasing popularity with fund managers globally since 2010. Despite some uplift in 2014, the amount of fund managers who have a net overweight to the sector is at its lowest level since 2008, according to the latest data from Bank of America Merrill Lynch.
However, those such as Pictet chief strategist Luca Paolini believe emerging markets will offer the best medium-term returns over the next five years.
The FE Research team recommends two active funds in the IA Global Emerging Markets sector in its FE Select 100. They also have the Vanguard Emerging Markets Stock Index, a passive fund, on the list.
Of the £900m Fidelity Emerging Markets and £1bn Somerset Emerging Markets Dividend Growth funds – the two active funds on the list – the former has performed better over three years and has doubled the MSCI Emerging Markets index’s gain of 14.67 per cent.
Performance of fund, sector and index over 3yrs
Source: FE Analytics
The FE Research team says fund manager Nick Price and his team did very well in 2013 thanks to their benchmark-unconstrained approach.
“This meant the fund wasn’t invested the ‘fragile five’ emerging economies most dependent on foreign investment: these five suffered the most when emerging markets fell on the back of an end to US monetary easing,” they said.
“This shows that although the manager focuses on bottom-up stock-picking, his macroeconomic analysis has also added significant benefits to investors. In the long run his approach of investing largely in consumer-facing companies in emerging markets looks likely to be a better way of generating returns than the large state-owned enterprises, banks and miners which dominate the benchmark.”
Square Mile also recommends both funds as well Somerset Global Emerging Markets, M&G Global Emerging Markets, Investec Emerging Markets Equity and JPM Emerging Markets Income, although Aberdeen Emerging Markets Equity is its highest rated in the sector with an ‘AAA’ rating.
The consultancy says the fund’s team, which is based in Asia, is “ably headed” by Hugh Young, the group’s head of equities.
“We have a high regard for the Aberdeen management team and their well-tested process, which over the long run has provided strong returns for investors,” Square Mile said.
“The unconstrained mandate and the emphasis on quality means that the fund can deliver a highly variable performance relative to the index, although in general, it has tended to defend well in falling markets.”
However, the firm’s analysts say the fund may not suit investors that seek benchmark-like returns but should instead appeal to investors with a long-term horizon.
The £1.8bn fund is the best performer in the sector over 10 years and top quartile over five years with a return of 13.62 per cent. This compares with a 12.19 per cent sector average and a gain in the index of 12.19 per cent
Performance of fund, sector and index over 5yrs
Source: FE Analytics
Barclays Capital says the second half of 2015 will be characterised by an acceleration in global economic activity that will show a material outperformance for emerging market equities.
“The key driving force behind emerging market earnings growth remains demand from the developed economies. Exports from emerging markets are closely related to the imports of developed economies. Weak demand from the developed economies during late 2014 and the early months of 2015 has been a key factor behind the negative growth in exports from emerging economies.”
However, they add that exports from emerging markets should improve as global growth accelerates.
Fidelity Emerging Markets and Somerset Emerging Markets Dividend Growth have respective ongoing charges figures (OCF) of 1.03 and 1.3 per cent. Aberdeen Emerging Markets Equity has an OCF of 1.24 per cent.
