Investors will no doubt know that emerging markets have been out of favour for some time now, with headwinds such as China’s slowing growth, falling commodity prices, weakening currencies and geo-political tensions all hurting sentiment.
That being said, they may well be surprised just how badly emerging market equities have performed, with the MSCI Emerging Markets index and the average IA Global Emerging Markets fund losing 4.63 per cent and 6.22 per cent, respectively, over the past five years.
Those losses over a relatively long period of time are bad enough, but when you compare those falls to the 73.59 per cent gain from the developed market-orientated MSCI World index over that time, the extent of the bear market is all too clear to see.
Performance of sector and indices over 5yrs
Source: FE Analytics
Those losses mean the average fund in the peer group is now underperforming the likes of the IA UK All Companies sector over the last 10 years.
There is no denying that emerging markets have faced a number of tough periods over the last half a decade.
In 2011, the index fell some 17.82 per cent on fears of a ‘hard-landing’ in the Chinese economy and while it rebounded somewhat in the rising market of 2012, concerns over the end of QE in the US along with the impact it would have on emerging market currencies led to a 5 per cent fall in 2013.
Again, though 2014 was relatively flat for the index, 2015 has turned out to be another terrible one as China’s plummeting equity market, sharp declines in commodity prices and the strength of sterling has led to a 10.89 per cent fall year to date.
While the sector average is down 6 per cent over five years, there has been a huge difference in returns between the best and worst performers in the peer group over that time with some posting gains of more than 30 per cent and others falling 40 per cent.
In terms of the ‘winners’ during this bear market, it has been one group which has completely dominated.
Source: FE Analytics
First State is often seen as one of the leading lights in the asset class and this has certainly held true during the recent difficult back drop with its Global Emerging Market Sustainability, Global Emerging Markets Leaders and Global Emerging Markets funds all among the top five performers with an average return of 28.13 per cent.
Star manager Jonathan Asante, who heads up the group’s Global Emerging Markets and Global Emerging Market Leaders funds, also has a segregated mandate in the top five with his SJP Global Emerging Markets fund occupying fourth spot due to its returns of 24.26 per cent.
First State have also delivered very consistent returns, with all three of the funds beating the index in 2011, 2012, 2013, 2014 and so far in 2015.
Source: FE Analytics
Asante and FE Alpha Manager David Gait, who heads up the Sustainability fund, have a focus on high quality companies with reliable earnings and businesses which offer a decent level of downside protection.
Square Mile, the investment research and consultancy, says that while this means the strategy can struggle in strongly rising markets – such as 2009 – it has perfectly suited the recent tough backdrop.
Speaking about the £2.4bn First State Emerging Market leaders fund, Square Mile said: “This fund has delivered a very strong track record but the emphasis on capital preservation and quality means it has tended to lag when the market is led by more cyclically sensitive and lower quality stocks.”
“The upside to such an approach is that the fund has remained remarkably resilient when markets have fallen and volatility has increased.”
It must be noted, however, that First State GEM funds – which are now closed to new investors – moved across to the IA Specialist sector recently due to their high weighting to developed market stocks – which in turn could have aided performance relative to their former peer group in 2015.
As the table shows, while First State dominates the list, another theme has developed in the sector over the past half-decade in the form of small-cap outperformance.
According to FE Analytics, Templeton Emerging Markets Smaller Companies, Aberdeen Global Emerging Markets Smaller Companies and JPM Emerging Markets Small Cap are all among the top 10 performers with gains of 25.74 per cent, 13.96 per cent and 11.98 per cent.
This is quite a surprising trend, given the perceived riskier nature of smaller companies and the fact the small-cap index has only narrowly outperformed the wider market over five years with losses of 2 per cent.
There are a number of reasons why these funds have performed well, though.
Not only are they headed up by experienced bottom-up stock pickers but as they hold less liquid stocks, many of the companies they own won’t have been swept away by the tide of redemptions from institutional and ETF investors over recent years.
The next best performing large-cap fund with returns of 21.25 per cent is PFS Somerset Emerging Markets Dividend Growth, which carries five FE Crowns, is headed up by FE Alpha Manager Edward Lam and has an AUM of £1bn.
Performance of fund versus sector and index since launch
Source: FE Analytics
It has also been a top decile performer since its launch in March 2010 with gains of 21 per cent while the wider market is down 10 per cent, as it has outperformed in each of the last five years.
PFS Somerset Emerging Markets Dividend Growth has a similar quality bias to the team at First State, and its returns over recent years suggest the importance of equity income funds as investors can be ‘paid while they wait’ (in the form of dividends) for the market to recover.
The fund sits on the FE Select 100 as our research team says there have been a number of reasons for its outperformance.
“The fund held up well in 2011, a disastrous year for most emerging markets funds, thanks to avoiding the popular BRICs – Brazil, Russia, India and China,” they said.
“It also did relatively well in 2013, the region’s other recent bad year, thanks to not holding energy stocks, utilities or Indian companies. Outperformance in good years has been helped by holding lots of IT stocks.”
“The manager holds high levels of cash in the fund when he can’t find the right opportunities, which has reduced the risk on the fund but also the income.”
Currently, Lam holds a hefty 14 per cent in cash. While it is an income fund, the manager targets a growing source of dividends rather than a high headline yield meaning the fund only yields 2.5 per cent.
Other ‘quality’ funds to feature on the list of top performers include FE Alpha Manager Nick Price’s Fidelity Emerging Markets and Hermes Global Emerging Markets.
While a quality growth strategy has been conducive to the recent environment, those funds which have a value bias have suffered massively.
The best example has been with Templeton Emerging Markets, which is headed up by the well-known Dr Mark Mobius – who tends to focus on stocks which are out of favour within the wider market.
According to FE Analytics, the now £10m fund has underperformed against the index in each of the last five years meaning it is the sector’s worst performer over the period in question with eye-watering losses of 40 per cent.
Performance of fund versus sector and index over 5yrs
Source: FE Analytics
Its performance over the past five years now means the fund is bottom quartile over 10 years with returns of just 14 per cent and a maximum drawdown – which measures the most an investor would have lost if they had bought and sold at the worst possible times – of 43 per cent.
Other funds to feature in the bottom decile over the past five years include Neptune Emerging Markets, Baring Emerging Markets and UBS Global Emerging Markets Equity which are all down more than 15 per cent.
