Some of the top fund managers in the emerging markets sector have underperformed so far this year, despite the under-loved area coming back into fashion. 
Emerging markets have been unpopular among investors for a number of years due to uncertainty around some of its biggest constituents like China and its economic woes, the future of US interest rates and falling commodity prices.
However, momentum has picked up of late, with issues in more developed markets driving investors into the sector.
In the UK and Europe, Brexit continues to weigh on sentiment and, though markets have picked up in the months since the EU referendum, many investors have already moved their money to other areas with uncertainty likely to remain the name of the game for some time.
Meanwhile, political uncertainty in the US has been coupled with the Federal Reserve’s reluctance to raise interest rates, despite an uptick in the world’s largest economy, which has also had a knock-on benefit to foreign companies with dollar-denominated debt.
Performance of indices in 2016
Source: FE Analytics
So far in 2016, emerging markets have outperformed their US counterparts by 10 percentage points and their UK rivals by 20 percentage points, as the above graph shows.
The spike in interest in the region since the EU referendum was notable, as well as its performance over the last month, which has been boosted by a number of managers and institutes who have become bullish on the region.
Indeed, investment into emerging market equity funds hit a 58-week high this week, according to data from EPFR Global.
However, given the sharpness of the rally and significant reversal in market trends over recent months, many funds in the space run by FE Alpha Managers have failed to keep pace with the index in 2016 so far.
Indeed, the fact that some of the largest members of the index that struggled during 2015 and 2014 when sentiment was weak towards the developing world have rallied the hardest means it is the managers who’ve made a name for themselves for protecting against the downside that have struggled the most.
The largest underperforming fund is £9bn Stewart Investors Asia Pacific Leaders, run by FE Alpha Manager David Gait and Sashi Reddy, who also have their Stewart Investors Asia Pacific Sustainability fund in the bottom quartile over the year as well.
Performance vs benchmark in 2016
Source: FE Analytics
The £9.6bn five crown-rated fund is the largest by some margin, but has returned 20.29 per cent to investors this year – more than 5 percentage points below its MSCI AC Asia excluding Japan benchmark’s 25.61 per cent.
Meanwhile, the group’s also five crown-rated £390m Asia Pacific Sustainability fund has also underperformed with returns of 22 per cent to investors so far this year.
However, as defensive funds this can be expected when the market is in a rally and both tend to perform better when the market is more volatile or falling.
Square Mile said both funds tend to perform better when the market is falling, adding that the Leaders fund “has lagged when the market is led by more cyclically sensitive and lower quality stocks”.
Indeed, both have outperformed the benchmark over the longer term and been in the top quartile of their sector over three, five and 10 years for total returns, risk-adjusted returns and maximum drawdown.
Also benchmarked against the MSCI AC Asia excluding Japan index are Mirae Asset Asia Sector Leader Equity, run by FE Alpha Manager Rahul Chadha, and JOHCM Asia ex Japan Small and Mid Cap, run by Cho Yu Kooi and FE Alpha Manager Samir Mehta.
Performance vs benchmark in 2016
Source: FE Analytics
The $419m Mirae fund has underperformed the benchmark by nine percentage points, while JO Hambro’s fund has lagged by more than 10 percentage points.
The Mirae fund, which launched in 2013, focuses on large, sector leading companies, that are domiciled in Asia, and aims to provide long-term growth, so it should come as no surprise that the fund, much like the Stewart Investors funds, have outperformed over the long term, sitting in the top quartile among its peers over three years.
The same is true of the £67m five crown-rated JO Hambro fund, which is also top quartile over three years.
The fund that looks at small and mid-cap companies with the potential to grow has been one of the least volatile in the sector over the last three years, with the lowest maximum drawdown – the amount an investor could have lost if buying and selling at the worst possible moments.
However, flows into emerging markets will tend to benefit large-caps (which make up a bigger proportion of the index) than smaller companies, which may explain why JOHCM Asia ex Japan Small and Mid Cap has failed to keep pace with the index.
Also on the list of the FE Alpha Managers underperforming in the emerging markets sphere this year is Nick Price and his five crown-rated Fidelity Emerging Markets fund.
Performance vs benchmark in 2016
Source: FE Analytics
The £1.2bn fund has lagged its benchmark by 10 percentage points, though it is another somewhat defensive fund which focuses on companies with cash on the balance sheet.
It avoids state-owned companies, as well as large index names, and is predominantly focused in Africa and Asia.
As a result of this diversification, the fund has been one of the least volatile in its sector and is in the top quartile for maximum drawdown and Sharpe ratio – which measures risk-adjusted returns.
Square Mile said: “We see this fund as a solid choice for investors seeking a broad exposure to emerging market equities.”
Also benchmarked against the MSCI Emerging Markets index are Hermes Global Emerging Markets and MI Somerset Emerging Markets Dividend Growth, run by FE Alpha Managers Gary Greenberg and Edward Lam respectively.
Performance vs benchmark in 2016
Source: FE Analytics
Hermes Global Emerging Markets has lagged more than the Somerset fund, underperforming the MSCI Emerging Markets by almost seven percentage points.
The $1.1bn five crown-rated fund aims to achieve long-term capital appreciation through a diversified portfolio, with the likes Ali Baba and Tencent in its top ten holdings.
These are relatively defensive holdings, and while the fund has not shot the lights out this year, it has been one of the top performers over a three-year period.
Meanwhile, Lam’s £1bn fund is focused on income growth, investing in dividend-paying equities.
These stocks tend to be more stable companies, with the likes of Samsung in its top 10 holdings, and the fund has been in the top quartile for volatility and maximum drawdown over the last five years.
The manager has also tended to hold a high level of cash if he hasn’t seen value in the market. While this approach worked in the more volatile conditions of recent years, the fund’s current cash weighting of 8 per cent will have dragged on potential returns.
Indeed, the fund has been a first quartile performer over a five year period and Square Mile said: “The fund may lag in strongly rising markets but we think the preference for firms with resilient revenue streams can help cushion losses when markets are falling.”
