Whether it’s the property market, the consumer or the leadership hand-over, China still dominates talk about emerging markets. There is a good reason for that with the country challenging the US for pole position as the world’s largest economy. Yet over-reliance on Chinese growth has made investors uneasy.
Not so long ago there were four countries on something of an even footing. The so-called BRIC nations of Brazil, Russia, India and China all offered investors healthy profits, and each had its own distinct characteristics. However, complications arose with an end to the commodity ‘super-cycle’, particularly for resource-dominated stock markets.
“If you go back a few years when the BRIC term was coined, the big theme was the commodities super-cycle – China using all the resources and Brazil and Russia being the suppliers,” says William Calvert, manager of Polar Capital’s emerging market growth and income funds.
“2009 was something of a ‘dead cat bounce’ on that theme and since then there has been a massive rotation out of all deep cyclicals into what you could call secular growth stocks, or quality at any price. We have a new extreme of undervaluation of cyclicals against secular on a relative price-to-book basis. It has become very extreme.”
Cyclicals out, infrastructure in
How a market has performed is largely down to how its indices are constructed – currently, whether or not it is full of cyclicals. As Calvert points out, Brazil has been a relatively poor performer over the past three years with Brazil equity funds losing an average 5% in sterling terms, according to Morningstar. This is largely because of the dominance of the likes of Petrobras and miner Vale on the BM&F Bovespa; however, that does not mean that these stocks should be avoided entirely.
Calvert explains: “Petrobras in 2007 was probably trading on a price-to-book of about 4x and it is now 0.75x. That was the biggest stock in the benchmark and it has had a massive de-rating. It will be an interesting story at some point because there will be some production growth coming through; it’s just the cost at which that production will come on is the issue.”
Perhaps the biggest opportunity in Brazil – given that it is hosting the next football World Cup and Olympics – is infrastructure. This is a theme which spans the whole emerging markets asset class. Alongside developments in the BRICs, there is a new ambitious public-private partnership project in the Philippines, while the Indonesian Government has recently passed a land reform law that will allow further development.
Investor magnet
Today, GEM funds are by far the most popular route for investors to access the developing world directly. But if you cast your mind back to before the credit crisis took hold, it was single-country funds that were then gaining traction.
From 2006 to 2008, new China funds were launched by some of the biggest retail names, including Jupiter, Threadneedle and Barings. India funds were also launched by the likes of Jupiter, Invesco Perpetual and Neptune. To a lesser extent there was also a fair share of new vehicles focused on Brazil and Russia.
Only India funds have delivered growth on aggregate over the past three years – around 3%, according to Morningstar. The largest are -offered by the likes of Aberdeen, First State, Fidelity and HSBC.
The pace of new launches has understandably slowed since, while assets in GEM funds have swelled – so much so that earlier this year, Aberdeen soft-closed its £3.5bn Emerging Markets Fund to protect its performance prospects (though most can still invest).
This prompted speculation that First State could well do the same with its £3.1bn Global Emerging Market Leaders Fund.
Faith repaid
There’s good reason why investors have favoured those funds (even though they are something of a duopoly). Over three years (to 14 Dec), the First State vehicle climbed 42%, while the Aberdeen fund was up 38%, according to FE Analytics. In the same period, total return from the IMA China/Greater China sector was essentially flat.
Alan Higgins, chief investment officer at Coutts, prefers a broader approach to accessing emerging markets, though he concedes it is hard to find alpha in the GEM funds available to him and adds that it can be difficult for large-scale investors to place money into the bigger funds. Currently, his team is using ETFs among its selection and he singles out Templeton China.
Higgins says: “BRIC is 45% of emerging markets, the four largest and most liquid markets, though singling them out is artificial. Infrastructure, food, luxury items – we are interested not just in what is listed there, but also who is selling to these markets.”
Roberto Lampl, head of emerging market equities at Baring Asset Management, sees the best opportunities in China, where his funds are around 10% overweight. But whereas the country was once characterised by its exports, he points out that the trade surplus has stopped growing.
“We have seen wage growth in China that has resulted in them having to shift production to other countries to gain competitiveness,” he explains. “On the higher value-added side, China is making some strides but countries like Mexico and Korea have gained share. So what we really like in China is the domestic cyclicals; we like financials within that, with a preference for insurance, and we like consumer discretionary, and selectively like certain materials.”
While China may still lead discussions on emerging markets, many retail investors may be underweight in the country – if they just hold, say, First State Global Emerging Market Leaders Fund, they would have around just 8% there compared to a benchmark weighting of 18.5%. Aberdeen Global Emerging Markets Fund is also underweight, as are other large GEM funds from big names such as M&G and F&C.
Undeterred
Despite the slowdown in emerging markets, retail investors continue to invest. The IMA Global Emerging Markets sector was the best seller in net terms for the first time in October 2012 with retail sales of £228m, the highest level for two years.
In its data for its funds platform, Allfunds Bank says it has seen renewed interest in emerging market funds, especially GEM funds. Regional funds, it says, have become less important as the allocation across different regions has become very challenging. This trend is supported from data elsewhere, although it is not something all agree with.
Peter Fitzgerald, senior portfolio manager at Aviva Investors, is one high-profile fund picker who has warned against an over-reliance on global funds given how few managers consistently outperform.
Specialisation
Fitzgerald says: “When you think that GEM funds have to cover Asia, Eastern Europe, parts of Africa and Latin America, it makes sense to have a specialist in each region. This becomes more important as the regions make up an increasingly large percentage of portfolios. We are overweight Asia and emerging markets within the cautious portfolio, with 10% of our holdings in these regions.”
A look at the varied performance of the BRICs over the past five years (see chart above) tells you all you need to know about why investors prefer a global manager to smooth out returns and access a wider basket of countries beyond the big four. However, that’s not to say that individual strategies will not deliver in the long term for those willing to take the turbulence.
Success though can really depend on an individual fund manager taking a stance on different sectors – whether that is consumer discretionary, financials or infrastructure – rather than falling in line with macro factors, such as supply and demand for resources, which can derail even the best investors if they are caught off-guard.
