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The data that proves just how much active emerging market funds have let long-term investors down

08 April 2016

Investors in emerging markets might have been better off tracking the index rather than buying an active fund over the long run, as most are underperforming over rolling 10-year periods.

By Gary Jackson,

Editor, FE Trustnet

The average member of the IA Global Emerging Markets sector is underperforming the market over the long term and a large number of funds have consistently lagged the index on rolling 10-year views, research by FE Trustnet shows, with some underperforming by more than 100 percentage points.

The underperformance of emerging market equities over recent years is well known, as concerns such as slowing economic growth in China, the prospect of tighter monetary policy in the US and falling commodity prices hammered investor sentiment towards the asset class.

FE Analytics shows that the developed market-focused MSCI World index has posted a 31.43 per cent total return over the past three years compared with a 5.64 per cent fall from the MSCI Emerging Markets index; over five years the MSCI World is up 54.04 per cent while emerging markets are down 11.22 per cent.

What may surprise some is that emerging market equities are also underperforming the developed world on a 10-year view, with the MSCI Emerging Markets’ 56.94 per cent falling well short of the 81.85 per cent surge in the MSCI World. The average IA Global Emerging Markets fund is lagging both indices over all three time frames mentioned.

Performance of sector and indices over 10yrs

 

Source: FE Analytics

There has been a recent turnaround in the fortunes of emerging market equities, with the MSCI Emerging Markets index climbing just over 10 per cent over the past three months. Over the same period, global developed market stocks are up around 3.5 per cent.

While this means emerging market equities do not look as cheap as they were, some commentators expect the asset class to rally from here.

Capital Economics chief markets economist John Higgins said: “The rally has left some measures of valuation looking stretched. Notably, the price/12-month forward earnings ratios of many countries are now well above their five-year average.”

“But we would not read too much into this. For a start, this measure of valuations remains attractive relative to equities in the developed world. Moreover, our view on emerging market economic growth suggests that there will be some upward revision to estimations of future earnings. In particular, we believe that better news from China is just around the corner and past form shows that emerging market equities have tended to track the performance of its economy.”

Investors eyeing a return to emerging markets, however, face a challenging task when trying to identify funds that have consistently outperformed the index over the long run.


 

In keeping with other articles in this series, we examined the 10-year performance of the IA Global Emerging Markets sector over rolling periods, viewed on a quarterly basis, going back to the start of 2001 (which is when our data on the MSCI Emerging Markets index begins). 

Within this time frame, there are 22 10-year periods – the first spanning 1 January 2001 to 31 December 2010 and the last covering 1 April 2006 to 31 March 2016. Any fund that has outperformed the index in each of these 22 periods could be said to have persistently rewarded the long-term investor, although it must be kept in mind that past performance is no guide to future returns. 

Rolling 10yr total returns of sector and index

 

Source: FE Analytics

Our data shows that the average IA Global Emerging Markets fund has underperformed the MSCI Emerging Markets index in each of the periods covered in this study – as the graph above makes clear.

The average 10-year underperformance of the index has been 15.81 percentage points. However, the worst 10-year period of underperformance was between 1 October 2002 and 30 September 2012, when the sector was 30.66 percentage points behind the index.

What’s more, nine of the 14 funds with a long enough track record to be included in this study have not beaten the index in any of the 22 periods looked at.

The worst performer, on average, has been the $148m HSBC GIF Global Emerging Markets Equity fund, where the average 10-year underperformance of the index has been 107.99 percentage points.

Another three funds have also seen average underperformance of the index of more than 70 percentage points.

These are Scottish Widows Emerging Markets (average 10-year underperformance of 89.51 percentage points), Legg Mason IF Martin Currie Emerging Markets (average 10-year underperformance of 74.84 percentage points) and F&C Emerging Markets (average 10-year underperformance of 74.14 percentage points).


 

Rolling 10yr total returns of funds and index

 

Source: FE Analytics

Adrian Lowcock, head of investing at AXA Wealth, suggests that many emerging market funds suffered in the past from investing too aggressively in growth, which left them overly exposed to market falls, and says a number of newer funds seem to promise better outcomes for long-term investors.

“Emerging markets can be very volatile and are very sensitive to the global macroeconomic picture. If you’re aggressively invested for growth in emerging markets – which historically many funds have been – then investors are very exposed to that,” he said.

“But a lot of these lessons have been learnt and there’s more funds coming out that have more of a defensive, ‘get rich slowly’ attitude to emerging markets, which 10 years ago would have been a very contrarian view – everyone expected to make a lot of money quickly, but exposed themselves to easily losing it.”

“These days, we’re seeing a change in emerging markets. People have seen what works in emerging markets: a focus on fundamentals, good quality businesses that are very shareholder orientated and not necessarily looking for the next big growth story that might not be supported by the right corporate structure.”

Lowcock highlights a number of emerging market funds that were not included in our study (due to having too short a track record) that he thinks are well placed to outperform going forward thanks to their process.

These include equity income strategies such as JPM Emerging Markets Income, because their underlying holdings tend to display higher levels of corporate governance, shareholder focus and long-term business philosophies.

He also highlights Fidelity Emerging Markets as more core, concentrated portfolio and Jupiter Global Emerging Markets, which has an unconstrained approach.

However, this does not mean that all the funds with a longer track record have a poor history of rewarding long-term investors. Our research found a handful of funds that have managed to outperform the index in each of the 22 decade-long periods we looked at – and we’ll reveal them in an article later today.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.