Asset allocation riches of emerging markets

An asset allocator’s stance on emerging markets has been the key to top quartile performance in recent years.

Over the past year, the average global emerging market fund has generated 48.3% returns, according to Trustnet. While over five years returns rise to 295%.

It is numbers like these that have helped global managers with big stakes in the emerging nations, like North’s John Husselbee and New Star’s Mark Harris and Craig Heron, deliver sector beating returns.

While investors look nervously at the US and try to guess the impact the credit squeeze might have on globe’s future growth, the emerging markets continue to generate stellar returns for investors.

According to New Star’s Heron there has been a shift of importance of emerging markets on the global stage.

“Emerging market countries comprise about 85% of the world's population and this year their economies will account for more than 50% of global gross domestic product growth,” he says

“While emerging equities have traditionally fallen more than their developed counterparts during periods of heightened risk aversion, during the recent volatility they continued to thrive.”

From the lows of mid-August, the MSCI Emerging Markets Total Return Index powered ahead, gaining 15.87% by the end of September. During the same timeframe, the S&P 500 Total Return Index rose only 8.77%. As further testament to their momentum, initial public offerings in emerging markets reached record levels in the third quarter.

According to Ernst & Young, seven of the top 10 new issues over the quarter were from emerging markets.

The China story has been particularly difficult to ignore, with managers such as Jupiter’s Phillip Ehrmann and Gartmore’s Charlie Awdry both doubling assets in the last year.

Ehrmann remains bullish on the region, despite the recent triple-digit returns.

“Over the next thre to five years I cannot be more positive,” he says.

Old Mutual’s Asian Select manager Suresh Sadasivan is another positive on the region.

“When you consider the cost of capital for Chinese investors, the shares are probably not overvalued,” he says. “Earnings growth has been good this year.

“The average P/Es for next year are 20x to 21x, meaning we are not in a bubble yet. Fundamentals are still in line with value.”

However Swip’s Asia Pacific manager Tim Dickson believes there is already an H-share bubble in China, with prices based on investor speculation rather than fundamental value.

“We are underweight on the H-shares and red chips,” he says. “It is hard to justify what is going on.”

It is not just China that has been attracting interest. India, Russia, Brazil – the remaining three BRIC nations are all seen as growth stories with tremendous potential.

New Star’s Heron has recently taken advantage of the market weakness to re-establish positions in India.

“This is a direct play on India’s infrastructure improvement, an area in which the developing Indian economy lags China,” he says.

By contrast, Aidan Kearney, fund of funds manager at Credit Suisse, has taken profits on his Chinese holdings and re-invested in Robin Geffen’s Neptune Russia fund.

Whatever your take on the individual nations, it is difficult to ignore the recent returns from emerging markets funds.

1 November 2007