Johnson says the nuclear game being played by the tiny Asian country highlights the need to have an investment strategy that can protect investors from worst-case scenarios. "[North Korea] demonstrates very clearly the risks involved in emerging market investing. You still do have these substantial tail risks that you just don’t have in developed markets," he explained.
He adds it is important for investors not to put all their eggs in one basket and that they should look for quality companies that can withstand some of the major risks in the developing world.
Johnson says there are four major headwinds affecting emerging markets today.
The transition from export-led to domestically driven economies
"The headwinds to emerging markets at the moment are, I think, quite clearly identified," he said.
"You’ve got various different issues confronting us as investors. At the core is the fundamental evolution of these markets from low input, low wage, high-savings rate economies to ones where your wages are going up, commodities are much more expensive than they were, savings rates are declining and so on."
"You’re shifting from those export economies to the concept of domestic consumption. That is hugely significant and can be quite a painful process as well," he added.
Johnson points out that periods of economic and social change in the West bred political and social unrest, a shift the emerging world is only beginning to experience.
"Inequality is an issue that comes straight from this and it has huge political consequences," he said.
"In the papers you see lots of issues of social unrest over wages and factory conditions. So that takes time to work through – in Britain that took 50 to 100 years for the industrial revolution to play through to a post-consumption society."
Inflation
"Whilst commodity prices have gone up substantially, wages have gone up too and that causes cost-input problems," Johnson continued.
"There’s a lot of sub-surface tensions displaying themselves in emerging markets that you need to be very careful of. Clearest identified is inflation, so you need to be very aware of that. That causes big problems in countries like China."
Corruption
Johnson says that while company fundamentals have been steadily improving in emerging markets, as evidenced by more and more companies adopting a dividend-paying culture, they are still combating corruption at both the corporate and sovereign level.
"We don’t have the issues of corruption in the West that you do in emerging markets. A lot of these governments have huge problems when it comes to operating efficiently without substantial levels of corruption, so we have to weather that as emerging market investors," he said.
"Yes we have to watch the macro environment. These are in many instances unstable regions," he added.
Illiquidity
As frequently happens in investing, the money chased the emerging market growth story of the last 15 years and, as a result, mass inflows have affected valuations in the sector.
"Recently, people have been neglectful of opportunities in the West and US particularly," Johnson said.
"We’ve been quite clear in the last few months that the developed markets might, on some levels, represent better value than the emerging markets if you’re looking for an immediate tactical allocation."
"On a valuation basis I don’t think that’s true for the long-term, but we’ve had a very good run over the last few years so we’ve got to be quite careful to be aware of the fact that attention and flows may shift and obviously make sure our portfolios are robust enough to weather that."
Somerset’s funds have performed well over their lives.
Somerset Emerging Markets Dividend Growth is a top-quartile performer over one and three years, while the four crown-rated Somerset Global Emerging Markets fund is top quartile over three years.
Performance of funds vs sector over 3yrs
Source: FE Analytics
The Somerset Emerging Markets Small Cap fund, which was launched in November 2010, is already closed to new investment because FE Alpha Manager Mark Asquith believes it is impossible to run a quality fund with such a focus with the massive AUM of some of his peers.
His fund is top-quartile over every period since launch, outperforming the IMA Global Emerging Markets sector by more than 10 percentage points over one year.
The Dividend Growth portfolio is currently yielding 3.2 per cent and requires a minimum investment of £2,000. It has an ongoing charges figure (OCF) of 1.36 per cent, comparatively low for an emerging markets fund.
The Somerset Global Emerging Markets fund also requires a minimum investment of £2,000 and has an OCF of 1.85 per cent.