Emerging market stocks have enjoyed a strong run over the opening five months of the year with close to 90 per cent of funds in the IA Global Emerging Markets sector already posting double-digit return for 2017 to date.
Recent years had seen widespread underperformance from emerging market equities, as investors sought the relative safety of developed markets. Data from FE Analytics shows that the MSCI Emerging Markets index has made just 50.3 per cent over the five years to 7 June – far below the 115.05 per cent rise in the MSCI World.
However, this started to reverse in the latter months of 2016 as investors around the globe became less fearful of the threat of deflation and started to embrace the reflation trade. This continued into 2017, with MSCI Emerging Markets’ 13.03 per cent return being double the gain seen by the developed markets index.
Performance of indices during 2017
Source: FE Analytics
Investors had been concerned about how emerging markets would stand up in the face of headwinds such as rising US interest rates, the impact of president Donald Trump’s reform agenda and China’s economic transition.
However, the impact of interest rate rises in the US appear to have been priced in while business-friendly governments in many countries have acting as support to investor sentiment. Furthermore, a cyclical recovery in commodities, which supports certain emerging markets, and a shift in emerging economies towards innovation, technology and consumption have been hailed as positives by investors.
Carlos Hardenberg, lead portfolio manager of the Templeton Emerging Markets investment trust, said: “The recent improvement in emerging market fundamentals is helpful for continued strength in emerging market equities, with these markets appearing undervalued relative to developed markets.
“At the stock level, valuations remain attractive and we have recently seen an inflection point in corporate earnings, which are now accelerating, reinforcing the potential for longer term outperformance of the asset class.”
Amid this backdrop, the average IA Global Emerging Markets fund has generated a 13.59 per cent total return, ranking it above popular sectors such as IA UK All Companies (9.13 per cent), IA UK Equity Income (8.53 per cent) and IA Global (8.02 per cent).
What’s more, FE Analytics shows that 87 per cent of the funds in the IA Global Emerging Markets sector have made double-digit returns over 2017 to date, while 51 per cent have beaten the rise in the MSCI Emerging Markets index.
If we look at the IA UK All Companies sector – the largest in the Investment Association universe – only one-third of its members have made 10 per cent or more in the opening months of 2017. However, 72 per cent are ahead of the FTSE All Share over this time frame.
Turning to individual funds and Baillie Gifford Emerging Markets Leading Companies sits at the top of the IA Global Emerging Markets sector with a 22.05 per cent total return.
Source: FE Analytics
The £509.8m fund, which is managed by Will Sutcliffe and holds four FE Crowns, is built around a concentrated portfolio of the larger companies in the emerging market space. Sutcliffe invests on a long-term horizon and has a preference for growth stocks, with Samsung Electronics, Taiwan Semiconductor Manufacturing Company and Tencent being the portfolio’s three biggest holdings.
Baillie Gifford Emerging Markets Leading Companies’ strong run is not limited to 2017, though, as it is in the peer group’s top quartile over one, three, five and 10 years. Over the past decade, it has made 108.76 per compared with 79.97 per from its average peer.
Newton Global Emerging Markets is in second place with a 21.67 per cent return. The £106.2m fund has been managed by Rob Marshall-Lee since September 2013 and over this time it has made a 64.10 per cent total return, against a sector average of 40.82 per cent.
The fund is based around Newton’s global thematic overlay, which identifies headwinds or tailwinds stemming from forces of change playing out in the global economy. On a stock level, the portfolio tends to own compounding businesses as well that those benefiting from factors such as strong brands or barriers to entry.
The only other IA Global Emerging Markets fund to make a return of more than 20 per cent over 2017 to date is MFS Meridian Emerging Markets Equity, which is up 20.24 per cent. Managed by Jose Luis Garcia and Robert W Lau, this $70.4m fund hold one FE Crown and is in the sector’s bottom quartile over one, three and five years.
While emerging markets are an inherently riskier part of the market and less than six months of performance is a very short time frame, there are plenty of investors who think their strong run could continue for some time yet.
Robin Geffen, manager of the Neptune Global Equity and Neptune Global Alpha funds, has been lifting his exposure to emerging markets since May 2016 and expects the asset class to generate compelling returns for many years.
“People had completely written off emerging markets but that’s when I think things became interesting. Valuations were low and remain so, but China was beginning to stabilise under more effective policy measures. The stabilisation of the Chinese economy was the bedrock of a complete turnaround in the opportunity set,” he said.
“Having languished under a deflationary environment, slower global growth and weak PMIs from their key importers, emerging markets rebounded last year as these trends began to reverse. Now we’re seeing the effect of these headwinds turning into tailwinds.
“So far our move into emerging markets has been positive, but we think there’s plenty of room for upside from here in a number of different areas.”