Thirty years since the launch of the MSCI Emerging Markets benchmark there is still a lot of misunderstanding about the group of fast-growing economies, according to fund manager Andrew Ness. 
Research by Franklin Templeton Investments found that just 10 per cent of investors’ portfolios are invest in emerging markets on average, with 58 per cent held in the UK assets, a potentially risky scenario.
An annual survey found that UK consumers take a broad-brush approach to how they think about emerging markets, typically based on outdated perceptions of the world.
Ness (pictured), a portfolio manager on the £2.3bn Templeton Emerging Markets Investment Trust (TEMIT), said that in the space of three decades emerging markets have transformed from economies reliant on commodity exports into more developed economies.
Indeed, emerging markets now stand at the forefront of areas such as technology and renewable energy.
“The emerging markets of today bear little resemblance to the emerging markets of 1989. Since that time, emerging markets have become far more outward-looking, while also developing stronger trading relationships between each other,” he said.
“We think investing in emerging markets boils down to the mismatch between perception and reality.
“We encourage investors to look beyond the headlines to see how emerging markets have become resilient, standalone economies.”
As such, Ness said that it is important to understand individual markets and to take a bottom-up approach to try to identify the best opportunities.
Below, Ness highlights three emerging markets that have been misunderstood by UK investors and the internal changes that are driving opportunities in each.
Russia
The first emerging market highlighted by the TEMIT manager is Russia, a potentially controversial country given its often fractious relationships with developed countries.
Nevertheless, some significant regulatory changes have led the Ness and co-manager Chetan Sehgal to reconsider some investment opportunities.
“The Russian government has implemented some politically challenging measures such as tax increases and pension reforms, with plans to raise productivity growth through higher spending on infrastructure, health and education,” he said.
“Several progressive dividend policies and strong buyback programs have emerged from Russia recently. But headlines have largely focused on geopolitical tension between the US and Russian governments. Over the years, we have worked with businesses in regard to governance factors. As such, some of these companies have increased their focus on shareholder returns.
One Russian stock example identified by the Templeton Emerging Markets Investment Trust team is multinational energy corporation, Lukoil.
Performance of stock since launch
Source: Google Finance
The team highlighted the oil company as an example of dealing with governance in emerging markets as the company introduced new dividends policies, ensured that any “free cash flow is now spent on share buybacks”, and giving minority investors a board seat.
India
The next emerging market is India, which – under prime minister Narendra Modi – is aiming to become a global leader in the manufacturing space.
“Emerging markets used to have a simple roadmap to growth: produce and sell abroad,” Ness explained. “Some countries offered large pools of affordable labour to become low-cost manufacturing hubs. This often left the fortunes of these countries vulnerable to changes in the developed markets they exported to.”
However, the manager said that emerging market economies have evolved and are becoming increasingly developed growing their high-tech exports to meet global demand.
“In India, innovation has become a priority. Its national strategy ‘Decade of Innovations 2010-20’ is committed to strengthening science, technology and innovation capacities,” said the TEMIT manager.
“Its objective is to increase gross expenditure on research and development to 2 per cent of India’s gross domestic product by 2020. The country’s commitment to innovation is also reflected in India’s ‘Make in India’ initiative to strengthen its manufacturing sector.”
Brazil
The final, misunderstood emerging market is Brazil, where renewable energy – an area that emerging markets are increasingly taking a lead in – is an important theme.
“In Brazil’s manufacturing sector, we’ve seen certain companies make considerable progress in regard to environmental considerations, which are starting to influence business decisions,” said Ness.
One example is auto parts manufacturer Mahle-Metal Leve which, Ness said, has worked to significantly reduce its carbon dioxide emission through the introduction of alternative biofuels in its internal combustion engines.
Performance of stock since launch
Source: Google Finance
“We believe this should further improve the use of renewable fuels in Brazilian cars, which are already mostly dual-fuel cars—vehicles that run on more than one type of fuel, i.e. gasoline blended with either ethanol or methanol fuel.”
Ness joined the trust in September 2018 shortly after Sehgal. The trust was previously managed Carlos Hardenberg and veteran emerging markets investor Mark Mobius.
Fund performance versus sector & benchmark over 1yr
Source: FE Analytics
Year-to-date, the trust has made a total return of 19.92 per cent compared with a 12.30 per cent gain for the MSCI Emerging Markets benchmark and a 7.28 per cent return for the average IT Global Emerging Markets peer.
The trust is trading at a discount to net asset value (NAV) of 13.3 per cent, is 1 per cent geared, has a yield of 2.04 per cent and ongoing charges of 1.03 per cent, according to the Association of Investment Companies (AIC).