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Emerging markets will underperform developed for a decade, says Thomson

07 July 2014

Rathbones' FE Alpha Manager has been cutting his direct and indirect exposure to emerging markets in his £411m Global Opportunities fund.

By Daniel Lanyon,

Reporter, FE Trustnet

Developed markets will outpace emerging markets for at least the next 10 years, according to FE Alpha Manager James Thomson, who says assumptions over long-term outperformance are dangerously misguided.

ALT_TAG The manager of the £411m Rathbones Global Opportunities fund says he expects a prolonged period of underperformance from emerging markets leading to a rebranding of the asset class by investors.

“Investors have a mind-set that has been calibrated to think emerging markets are growing very quickly, while developed markets are much more steady and cash generative, but that is not going to be the case anymore,” he said.

“Investors are going to have to realise that things are going to be much more volatile in emerging markets – if not just plain bad – over the next decade.”

“Developed markets are going to be the place to be for the next 10 years. Don't believe the emerging market hype. You are much safer and will see better returns in developed markets.”

Thomson says that slowing growth will be a significant headwind to emerging market companies, and they have factored in such high levels in the past.

He believes that China restructuring from an investment-led to a consumption-driven economic model will be particularly painful.

He adds that a number of developing economies will have to battle inflation, overcapacity and overinvestment, as a result of the boom years over the last decade.

Over the past 10 years growth in emerging market indices has trounced developed markets.

The MSCI China and MSCI Emerging Markets indices have returned 289.48 and 235.25 per cent, respectively, with the FTSE All Share and S&P 500 not even coming close.

Performance of indices over 10yrs


Source: FE Analytics

This strong upward trend has been accompanied by far greater volatility, however.

Emerging markets have a max drawdown – which measures how much an investor would lose if they bought and sold at the worst possible times – of 52.21 per cent over the period, compared to 35.98 per cent from the S&P 500.

Emerging markets have come back to earth in recent times however, with fears over a slowdown in Chinese economic growth and QE tapering in the US both big contributors.

Hints of an end to QE by central banks in May last year and its implementation in January 2014 caused two significant sell-offs in emerging markets.

Both MSCI China and MSCI Emerging Markets are down over three years, whilst the S&P 500 and the FTSE All Share are up 45.23 per cent and 30.03 per cent, respectively.

Performance of indices over 3yrs


Source: FE Analytics

Many managers have started buying up battered emerging market stocks and funds in recent months, believing that the sell-off has created a compelling buying opportunity – particularly for long-term investors willing to stomach short-term volatility.

However, Thomson believes emerging markets could falter for a significantly longer period.

He does not hold any direct emerging market plays in Rathbones Global Opps and has also been selling out of developed market companies with indirect emerging market exposure.

“I sold out of LVMH last year over concerns about their exposure to emerging markets and switched our holding to Tiffany's, which is a much more developed market brand,” he said.

Thomson has been at the helm of the Rathbones fund since November 2003. Alexandra Jackson joined as his deputy in September 2008.

Over the past 10 years it has returned 209.17 per cent, almost doubling the returns of the IMA Global sector average. The FTSE World index has gained 137.64 per cent over the period.

Performance of fund, sector and benchmark over 10yrs


Source: FE Analytics

While Thomson is very cautious in his outlook for emerging markets, he thinks that developed markets have a lot going for them at the moment, and expects them to deliver strong returns in spite of their strong showing over the past five years.

Rathbone Global Opps has been steadily increasing its exposure to US equities over the past 18 months from approximately 32 per cent to more than 66 per cent.

Thomson says the majority of his positions look to tap into the recovering domestic consumer.

He says he has been switching out of growth companies into more value-orientated names in recent months, pinpointing the increasing demand for internet retailing as a sweet-spot for investors.

“Online is an interesting area but it is never simple. Tech has been struggling whilst utilities have roared back, which is a very strange phenomenon,” he said.

“Broadly speaking the online area of the market is taking market share from bricks and mortar companies because they tend to offer very good services, very good prices and are a very convenient way of buying products.”

One online retailer Thomson is less optimistic at the moment is FTSE AIM-listed company ASOS.

The manager included it as one of his largest holdings in 2013, but has sold down his position in recent months. He has missed out on the worst of its disastrous 2014, but retains a small weighing to it.

“[ASOS] has had a torrid time recently. A big part of their problems is not the products or general customer proposition or anything that made them successful in the in the first place; ASOS's real problem is currency because sterling is so strong where they sell products,” he explained.

“In Australia, where the dollar has declined 20 per cent against sterling, prices have skyrocketed. Naturally the Australian consumer stops buying it.”

“It is a stock I still like but it is in the penalty box and sometimes you just have to see what happens because I just don't know what the future holds for the company. However, I believe in it enough to have a 1 percent holding.”

Rathbone Global Opps is a high conviction portfolio of only 50 stocks. It has clean ongoing charges of 0.8 per cent.


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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.