Sector report: Global emerging markets storm ahead

Over the past six months funds invested in global emerging markets have outperformed their developed market counterparts by a country mile, but will the rally last?

Emerging markets had an inauspicious start to the year, as fears over the potential impact of the US's monetary tightening programme prompted the second mass sell-off in the region within six months.

Between 1 and 31 January, the Investment Management Association's (IMA's) global emerging market sector lost 6.6%, making it the worst performer in the IMA universe by nearly 2%.

The MSCI Emerging Market index also shed nearly 6% during the period, close to double that of the MSCI World, while local currency emerging market bond yields rose an average of 200 basis points to 7.25% - the highest level seen since 2010.

Remarkable recovery

Since February, however, emerging markets have witnessed a remarkable recovery, the MSCI Emerging Markets index returning close to 15% in the six months to 20 August, compared to just 6% from the MSCI World.

Over the same period the IMA global emerging market sector returned 12% - more than four times that of the IMA global sector at 2.9%, and significantly more than the 1.6% loss seen in the UK all companies sector between February and August.

According to Jan Dehn, head of research at Ashmore, this rally is unsurprising given the nature of the sell-off seen both in June 2013 and in January this year.

"That this sell-off embraced all asset classes in emerging markets, all countries and all regions was way in excess of what was justified, especially when you take into account what happened to fundamentals last year, which was nothing.

"We had 4.5% GDP growth in emerging markets in 2013, which was completely in line with trend, while we didn't have a single sovereign default and neither did a single country have a balance of payments crisis and run out of reserves," he says.

For Dehn, an emerging market recovery was therefore inevitable, as those investors able to "think for themselves" rather than follow the herd - a trend the analyst laments - piled into grossly undervalued assets.

Top-performing funds

During the rally some lesser-known emerging market funds managed to push their way to the top of the table. These include the Carmignac Ptf Emerging Discovery fund, which over the past six months is the best-performing fund available to private investors within the IMA global emerging markets sector, returning 19.5%.

Run by French asset manager Carmignac Gestion, the Emerging Discovery fund invests in small and mid-cap emerging market companies and has a focus on domestic regional demand, as demonstrated by its 40% weighting in consumer products.

Following the smaller companies theme, the JPMorgan Emerging Market Small Cap fund is the second best-performing retail fund between February and August, delivering 19.35% for investors, while Aberdeen Global Emerging Markets Smaller Companies also features in the top quartile with a return of 17.9% over the period.

Top-performing multi-cap funds include Lazard Emerging Markets, which was the third best-performing retail fund overall, delivering 19% between February and August.

Managed by James Donald, the 17-year-old fund is a long-time top performer and invests in well-known emerging market names including Samsung, Banco Do Brasil and Russian oil giant Gazprom.

After a middling couple of years Aberdeen Global Emerging Markets Equity managed to pick itself up by the bootstraps, returning 16.7% between February and August compared to just 6.7% over the past year.

The fund's holding in Taiwanese industrial firm Taiwan Semiconductor has proved a significant boon during the period, as its share price has risen nearly 18% over the past six months, helping to turn the fund's waning fortunes around.

Longevity

Emerging markets' comeback will no doubt be pleasing news for existing investors in the region, but for new buyers the question is whether or not the rally has already run out of steam.

Perhaps unsurprisingly, Dehn thinks not: "You are still looking at price/earnings ratios in emerging markets that are substantially below those that you get in developed markets, and this year emerging economies are set to grow at least twice as fast as developed economies.

"Unfortunately there are sections of the international investor community that turn into headless chickens whenever somebody says 'boo', so you will see price volatility, but it's important to look at the fundamentals. Use that volatility to buy into some solid stories at very attractive entry points," he says.

Derek Power, client portfolio manager on the team of Schroders' newly launched QEP Global Emerging Markets fund, is largely in agreement with Dehn; however, he does offer a word of caution when it comes to choosing exactly which areas of emerging markets to invest in right now.

"Emerging market equities currently trade at a significant discount to developed markets, but while this appears very compelling, not all countries and companies are as attractive as might be thought. This is why we believe that selecting the right companies as well as assessing the country risk is crucial," says Power.

While full details of Schroders' new fund are yet to surface, its offshore component has its largest exposure - at 58% of the portfolio - invested in the Asia Pacific region, with its top ten holdings consisting entirely of well-known Asian names including Samsung, Hyundai and China Mobile.

Money Observer Rated Fund Fidelity Emerging Markets also has a large exposure to the Asia Pacific region at around 40% of the portfolio; however manager Nick Price has been reducing his exposure to both Korea and Taiwan on concerns over low growth prospects.

"[Korea and Japan] look Japanese-esque in their nature, with super low inflation, high penetration of the consumer market and relatively muted demand. We tend to own only the tech stocks in those two markets," says Price.

In comparison Price is more bullish on companies within South America, particularly Brazilian banks such as Itau and BTG Pactual, both of which he owns in the Luxembourg-domiciled version of his fund.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.