The current dovish stance from the US Federal Reserve could bode well for emerging market equities, according to Stockdale Securities, which is arguing that investors should switch exposure from commodity funds to this asset class.
Emerging markets equities have endured a tough few years after concerns such as tighter US monetary policy, slowing economic growth in China and plunging commodity prices led them to underperform the developed world stocks.
FE Analytics shows the MSCI Emerging Markets index is down 4.62 per cent over five years, while the developed market-focused MSCI World index has risen 59.05 per cent.
Performance of indices over 5yrs
Source: FE Analytics
Emerging markets have rallied this year, however, after it looked increasingly likely that the Fed would carry out fewer interest rate hikes than expected in 2016. The MSCI Emerging Markets index is up 8.36 per cent over the year to date; the MSCI World has gained just 2.93 per cent.
Stockdale Securities analyst Saumya Banerjee says this could prove to be beneficial to emerging market equities in the near term, although he suggest that a long-term rebound could also been on the cards.
“We have consistently been cautious on emerging markets. However, the dovishness of the Fed does help emerging markets in the short term. It significantly reduces the risk of a sharp devaluation of the yuan, which was one of the key risks for emerging markets,” he said.
“We believe the Fed may be forced to reverse its dovish outlook towards the end of 2016 as wage inflation accelerates. However, we see a higher probability of a sustainable rally in emerging market equities. We feel that we may actually be near the end of a period of underperformance of emerging market equities.”
Banerjee is less positive on commodities, however, saying that Stockdale is “cautious” on the commodity cycle. He says investors should consider using the recent rally in funds focused on this area – the average Investment Association commodity fund is up 23.55 per cent over 2016 so far – to sell down exposure and buy into emerging markets instead.
One fund he tips is the £381.7m Utilico Emerging Markets investment trust, which focus on investing in infrastructure, utilities and related sectors in the developing world. Stockdale acts as broker and/or adviser to this trust.
“Funds like Utilico Emerging Markets, with their focus on real assets whose utilisation is likely to grow faster than GDP have strongly outperformed the MSCI Emerging Markets index,” Banerjee said.
“Given the major reorientation in growth that we are likely to see in countries like China we expect to see Utilico Emerging Markets’ management to continue to deliver strong relative performance.”
Performance of trust vs sector and index over 5yrs
Source: FE Analytics
As the above graph shows, the four FE Crown-rated trust has made a strong total return – close to 35 per cent – over the past five years while its average peer and the index are both down more than 4 per cent.
Banerjee adds that portfolio manager Charles Jillings has “significant expertise” in identifying unique opportunities in emerging markets. An example of this is largest holding Malaysia Airports Holdings Berhad, which owns 39 out of the 40 airports in Malaysia.
Although Jillings expects airline passenger growth in emerging markets to be substantial, he has consistently avoided own airline stocks – which is one of the more cyclical parts of the equity market. Instead, he believes Malaysia Airports Holdings Berhad will witness annual growth in passenger numbers of around 10 per cent as it capitalises on capacity constraints at regional airports like Hong Kong, Singapore and Bangkok.
Utilico Emerging Markets has ongoing charges, including a performance fee, of 1.85 per cent, is trading on a 12.79 per cent discount and yields 3.25 per cent.
Another portfolio highlighted by Banerjee is the £213.4m Advance Developing Markets Trust, which is a fund of funds. Stockdale also acts as broker and/or adviser to this trust.
“Advance Developing Markets Trust, with its ability to switch between open and closed-end funds, has added value for its shareholders since Andy Lister and Bernard Moody took over as portfolio managers at the beginning of July 2014,” he said.
“We believe that current widening of discounts in several funds in the emerging market space has created attractive entry points for the managers. Since the start of the year the fund has been buying JPMorgan Global Emerging Markets Income Trust, Morgan Stanley China A-Share Fund and BlackRock Latin American Investment Trust on attractive discounts.”
Performance of trust vs sector and index under Lister and Moody
Source: FE Analytics
The trust’s largest holding is the closed-ended Weiss Korea Opportunity fund. This portfolio has performed strongly in recent times (it’s up 17.44 per cent over six months) thanks to signs of improving corporate governance in its underlying companies.
In addition, the Advance Developing Markets Trust has been rotated towards eastern Europe where Lister and Moody see highly attractive valuations, moderate growth and the potential for further stimulus, which could be positives for investors in the region.
Advance Developing Markets Trust has ongoing charges of 1.19 per cent, is trading on a 14.88 per cent discount and yields 0.91 per cent.
