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Metcalfe: Now has to be the time to buy emerging market funds

24 November 2015

IBOSS’ Chris Metcalfe tells FE Trustnet why he is buying a third, higher risk emerging markets fund for his client portfolios.

By Alex Paget,

News Editor, FE Trustnet

The question of how much longer emerging market equities can struggle relative to developed markets has dogged investors for a number of years now.

As investors will know, as soon as a buying opportunity has seemingly opened-up in the developing world, macroeconomic headwinds, worse than expected data out of China or a comment from a member of the US Federal Reserve (Fed) have caused prices to fall further.

Thanks to issues such as the uncertainty over Chinese economy, painful currency movements and falling commodity prices, FE data shows the MSCI Emerging Markets index has now lost 10 per cent over five years.

The MSCI World index (which is developed market only) has returned 60 per cent over that time.

Performance of indices over 5yrs

 

Source: FE Analytics

Many are still avoiding emerging markets all together, given the Fed is likely to raise interest rates next month and China’s future remains very unclear.

However Chris Metcalfe, investment director at IBOSS, thinks that given the difference in performance and the low valuations now on offer, the trend has gone too far.

“Emerging markets are where, over the next 10 years, the growth is going to come from regardless of the strength of the dollar and regardless of when the US Federal Reserve moves rates,” Metcalfe (pictured) said.

IBOSS is a white label investment company that provides model portfolios for advisers. They have been running portfolios since 2008 and Metcalfe says he has really only used two funds for his emerging market exposure over the past three years – PFS Somerset Emerging Markets Dividend Growth and Fidelity Emerging Markets.

However, Metcalfe says now is the time to bring a third fund into the mix.

“We have had very good performance from the two funds but the reason we want to bring a third fund in because they are both relatively defensive and we are actually quite optimistic about emerging markets.”

“I’m talking about being bullish over the medium term here because whether or not the Fed moves in December, February or whatever – our clients don’t invest on that basis. We love talking about funds and markets because we don’t get out much, but to the end user client, they couldn’t care less.”

“It’s not really going to decide their pension income when the Fed moves, is it?”

“Overall, we think the valuations are much better than they have been and so for all the places you want to be active at the moment, this is it. We can’t just go sit here and keep waiting, so we want to bring a third fund in.”


 

Both the £931m PFS Somerset Emerging Markets Dividend Growth and £880m Fidelity Emerging Markets funds are run by FE Alpha Managers (Edward Lam and Nick Price, respectively), carry five FE Crowns and sit in the IA Global Emerging Markets sector’s top quartile since launch.

They also focus on a quality growth approach, which has worked well over recent years given the depressed sentiment towards the asset class.

According to FE Analytics, an equally weighted portfolio of the two funds has returned 9.98 per cent over five years, beating both the index and sector which are in negative territory. On top of that, the portfolio has had a lower annualised volatility, downside risk score and maximum drawdown than the sector and index over that time.

Performance of IBOSS’ emerging market funds versus sector and index over 3yrs

 

Source: FE Analytics

However, given Metcalfe thinks emerging markets are due a rally and will outperform over the coming decade, he wants to bring in a fund which (although may give investors a rougher ride) can take better advantage of a rising market.

A number of market commentators have told FE Trustnet that investors need to change the way in which they view emerging markets given the slowing growth now on offer as well as a divergence in growth trajectories among different economies.

For example, while the quality growth approach to the developing world (which has been championed by the likes of Aberdeen and Stewart Investors) has worked well over the longer term, it may struggle in this new environment.

“We have been looking for some time for some emerging market managers with a value bias. Emerging markets have really been a growth story over the last 10 to 15 years,” John Ventre, the former head of multi-asset at OMGI, told FE Trustnet last year.

“In the context of a ‘de-emerging markets’ theme and as the growth outlook looks a lot less certain, while at the same time valuations looks really compelling, in turn the usual manager selection on its head.”

He added: “The very successful quality growth managers out there in the market, which we have owned historically, are probably not best positioned to capture the new dynamic in emerging markets.”

Performance of funds versus sector and index over 15yrs

 

Source: FE Analytics


 

Metcalfe admits, however, that there is a genuine lack of value-orientated emerging market funds available to investors as many groups have copied the successful strategy which has been used by Aberdeen and Stewart Investors.

“I think there is a real danger there and that’s why we are going to buy in a third fund,” Metcalfe said.

“I think there is too much commonality between our two existing holdings a lot of these quality funds to tend to undershoot during strong rallies, which is fine and it’s worked OK recently because the last thing you’ve wanted is anything exciting – you’ve wanted a fund that is safe as houses.”

“It’s not going to be a smooth ride but if you have the right managers with the right potential, you should do very well from emerging markets.”

While it still follows a growth approach, one fund Metcalfe is considering is the newly-launched Man GLG Unconstrained Emerging Equity portfolio.

The fund is headed-up by the former Carmignac duo of Simon Pickard and Edward Cole and, as it name suggests, is designed to be benchmark-agnostic. Though the managers aim to own high quality companies, there is a valuation overlay given they prioritise businesses with an undervalued free cash flow yield.

The fund was only launched over the past few weeks, but Pickard and Cole used the same process during on their time running Carmignac Emergents.

Performance of fund versus sector and index under Pickard

 

Source: FE Analytics

Pickard managed the fund between September 2008 and February 2014, over which time it returned 59.09 per cent meaning it beat the sector and index. During that time, it capitalised on rising markets such as 2010 and 2012.

In their new fund, Pickard and Cole are overweight India, Israel and Saudi Arabia as well as sectors such as consumer discretionary, technology and materials – suggesting the fund is geared up for a more cyclical rally.

"In terms of cyclically adjusted P/E ratios, emerging markets are now trading at six times which is the lowest level since 1992. The US, on the other hand, is on 22 times. If you are thinking about money making opportunities over the next 10 years, then it is probably emerging markets rather than developed markets,” Cole told FE Trustnet last month.

 

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