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Gregory: You must ditch your catch-all emergings market fund

19 January 2015

Psigma’s Tim Gregory warns that investors are putting their capital at risk if they simply buy a catch-all global emerging markets fund in the current environment.

By Alex Paget,

Senior Reporter, FE Trustnet

Investors should sell their global emerging markets funds, according to Psigma’s Tim Gregory, who says they need to be very selective when it comes to their exposure to the developing world as they “may end up winning on one hand and losing it all on the other”.

Following a number of years of underperformance relative to the likes of the US and UK owing to slowing economic growth, falling commodity prices, various political issues and the impact of tighter monetary policy in the US, global emerging markets funds bounced back and rallied for the large part of 2014.

Up until the sell-off in September/October, the average fund in the IA Global Emerging Markets sector was outperforming all of the major developed equity sectors. FE data shows that while they gave back most of their returns, emerging market funds still outperformed the UK, Europe and Japan.

Performance of sectors in 2014

Source: FE Analytics

A number of experts have said that funds within in the Global Emerging Markets sector now look attractive given that they have fallen, but Gregory – head of global equities at the wealth manager – says investors should sell “catch-all” emerging market funds and be far more selective, as there will be a huge discrepancy in performance between the different regions that comprise the index.

“This has been a very interesting theme for us and a very difficult theme at the same time, because we think emerging market equities are cheap, but you simply cannot bundle them all together,” Gregory (pictured) said.

“You have to be very careful and very selective. You cannot just say ‘we love emerging markets’, you’ve got to look at different components of emerging markets and select managers depending on the territories you like.”

He added: “You can’t throw a blanket over it and buy an emerging market fund that has all of it covered because you may end up winning on one hand and losing it all on the other.”

For example, Gregory is avoiding economies with a current account deficit at all costs as they will be hit by the tightening of monetary policy in the US. Also, like Margetts’ Toby Ricketts, Gregory says a fall in the oil price will hit the likes of Brazil. 

“We like India, we like China – although Chinese stocks have really run hard and probably need a pause for breath and we would like to buy them again on weakness. But, we are very cautious about economies like South Africa, Brazil and Turkey – deficit countries.”

One area he is positive on is China. Following a visit to Shanghai last summer, he decided to buy on the back of exceptional valuations and the confidence that there wouldn’t be a Lehman Brothers-style catastrophe in China.

However, though Gregory is still positive, he says investors may need to be patient as he expects the market to cool after its recent phenomenal run and has since pulled his weighting back to neutral.

“We felt that, helped by this introduction of the new trading between Hong Kong and Shanghai, Chinese equities were due to rally strongly. I have to say, we did not expect to get all of that performance in a six-week period between the middle of November and the first week of January.”

Performance of indices over 3 months

Source: FE Analytics

“As a result, we feel that Chinese equities after this incredible move – which really hasn’t been based on any change in the fundamentals, apart from some moderate easing of policy – have moved from being incredibly cheap to justifiably cheap.”

“We cannot ignore that there are concerns over shadow banking and there are concerns over a dislocation in the property market where there is over-supply and over-leverage, so we don’t expect a huge rebound. We did reduce our exposure to Chinese equities last week.”

For those who want to buy China if its market does pull back over the coming months, there are number of highly rated portfolios which concentrate on the region.

The three five crown-rated funds in the IA China/Greater China sector are Raymond Ma’s £20m Fidelity China Consumer fund, Vanessa Donegan’s £110m Threadneedle China Opportunities fund and Lorraine Kuo and Mike Shiao’s £350m Invesco Perpetual Hong Kong & China fund.

Another option could be Dale Nicholls’ Fidelity China Special Situations investment trust, which had been managed by former star manager Anthony Bolton up until last year and has a more mid-cap bias.

The five crown-rated trust has considerably outperformed its MSCI China benchmark since Nicholls took charge in April 2014 and Cantor Fitzgerald’s Charles Tan recently added it to his recommendation list

“In light of the tremendous longer term potential of the Chinese economy, but bearing in mind the macro challenges it faces in the short term, Fidelity China Special Situations is, in our view, the ideal structure with which to access the growth and nascent liberalisation of the Chinese equity market,” Tan said.

The trust is currently trading on an 11 per cent discount, which is wider than its one and three-year average discount, according to the AIC. However, it is quite highly geared at 23 per cent and has ongoing charges of 1.46 per cent, which doesn’t include its performance fee.

Gregory also likes India and says he is looking to buy more over the coming few months.

“The other emerging market we are very keen on, but did extremely well last year, is India. After peaking at 29,000 in September/October, it has done nothing now for three months. If we saw a fall back to 26,000 on the Sensex, you would see us going long in that area again,” Gregory said.

Following prime minister Narendra Modi’s election victory in the spring and in anticipation of his pro-growth policies, the MSCI India index ended 2014 with a return of more than 30 per cent. However, as the graph below shows, the index is down 1 per cent since September.

Performance of indices in 2014

Source: FE Analytics

FE data shows there are 16 funds in the IA universe which focus exclusively on Indian equities and every one of them beat the index in last year’s bull market. 

The list of funds includes the five crown-rated Matthews Asia India fund, Aberdeen Global Indian Equity and Kunal Desai’s Neptune India fund.

Another reason why investors may want to avoid funds within the IA Global Emerging Markets sector is their performance over recent years, though as we know past performance is no guide to the future.

Nevertheless, an FE Trustnet study conducted last year showed only 34 per cent of large-cap emerging markets funds outperformed the MSCI Emerging Markets index over the previous five years. 

Also, when we removed the highly rated but now closed Aberdeen and First State funds from the study, it showed that only 24 per cent of active funds in the sector managed to beat the index over that time.

In an article later this week, FE Trustnet will reveal the country specific emerging market funds which have consistently outperformed their respective benchmarks over the years.

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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.