Metcalfe: The volatile funds that’ll drive our portfolios over the long term

Now is the time to buy into emerging market equities even though volatility is likely to persist over the short term, according to Chris Metcalfe at IBOSS, who believes his recently purchased units in Newton Global Emerging Markets will stay within his portfolios for the long term and generate significant growth.

Thanks to various macroeconomic headwinds such as China’s slowing growth, falling commodity prices, a stronger US dollar and the implications of tighter monetary policy in the US, emerging market equities have been one of the worst hit areas of the market over recent years.

According to FE Analytics, for example, the MSCI Emerging Markets index has lost 11.33 per cent over five years compared to a 52.92 per cent gain from the developed market-focused MSCI World index.

Performance of indices over 5yrs

Source: FE Analytics

It means that many investors have been hit by buying into emerging markets on the grounds they look cheap, only to see those valuations continually fall.

Though Metcalfe – an investment director at IBOSS Ltd – fully accepts volatility will persist, he says that as emerging markets have underperformed developed markets from a relative perspective for more than six years, valuations are now very low and, as the large majority of reasons why investors used to love the asset class before its fall from grace are still intact, now is the time to take the plunge.

“There is no doubt we have had plenty of false dawns in emerging markets,” Metcalfe (pictured) said.

“We initially said we wanted to increase our allocation in November last year and over the following few weeks it did not look like the best strategy, but we are really thinking about the longer term here.”

“You’ve got to try and ignore the day-to-day volatility as, from our perspective, it is better to hold assets which are undervalued relative to other areas of the market and their history rather than assets which are richly valued.”

As such, Metcalfe – who runs model portfolios and well as four newly launched funds of funds – started increasing his weighting in February. He has reaped the rewards so far as improved global investor sentiment has meant the MSCI Emerging Market index is up 17 per cent since mid-February – but he isn’t getting carried away.

“When we actually increased our exposure in February, emerging markets have been one of the best asset classes around but we know we are in for a very volatile period with people wondering what the Fed will do next and with a US election on the horizon – and goodness knows where that will take us.”

In a recent FE Trustnet article Ewan Thompson – manager of the Neptune Emerging Markets fund – explained that though valuations are certainly low in his asset class, the fact the US dollar is likely to strengthen means there is little for him to be overly excited about at this point in time.

“Over the last five years, we have had these constantly had these short-term rallies in emerging markets but to make them sustainable, we need a weaker dollar,” Thompson said.

Metcalfe has sympathy with that view, but says there is little point trying to time the market when he expects to hold emerging market equities for the next 10 years.

“Global emerging market equities are going to be pulled around by the nose by the dollar, but ultimately the developing world is where the best long-term growth potential is.”

Metcalfe has had exposure to emerging markets for a number of years, but they have been portfolios which have flourished in what has been quite a messy bear market for the asset class – Somerset Emerging Markets Dividend Growth and Fidelity Emerging Markets.

According to FE Analytics, for example, an equally weighted blend of the two portfolios has returned 14.52 per cent over five years compared a 10.27 per cent loss from the IA Global Emerging Markets sector average.

It has also been far less volatile, had better risk-adjusted returns and a much lower maximum drawdown than the sector average and the index over that time.

Source: FE Analytics

Metcalfe added: “Somerset and Fidelity, though both managers would argue there is little commonality between the two funds, have shown great defensive characteristics over recent year which has what has been needed.”

“Let’s face it, with the benefit of hindsight, the best action would have been to completely avoid emerging markets altogether.”

While he rates the two portfolios highly, Metcalfe says he wants to add a fund to his blend that has the propensity to take greater advantage of a rising market.

He has therefore upped his exposure to the asset class by adding Rob Marshall-Lee’s five crown-rated Newton Global Emerging Markets fund.

The fund, like others managed by Newton, has a thematic overlay but Marshall-Lee tends to favour growth-orientated stocks. While that is similar to the Fidelity and Somerset funds, Newton Global Emerging Markets has had different risk characteristics over the past five years.

FE data shows, for example, that the Newton fund has been slightly higher beta, a higher annualised volatility, bigger maximum drawdown but a greater maximum gain than Somerset Emerging Markets Dividend Growth and Fidelity Emerging Markets since its launch in May 2011.

Nevertheless, the fund has comfortably outperformed both the sector and index since inception with returns of 13.28 per cent.

Performance of fund versus sector and index since launch

Source: FE Analytics  

The fund has been a top quartile performer and beaten its benchmark in every year since launch, which includes both rallying and falling markets.