Emerging markets look for light at the end of the tunnel

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The old market saying that you can have cheap assets and low valuations, just not both at the same time, applies to continental and national equity indices as well as it does to individual stocks or bonds. Perhaps one approach to sniffing out where the value may lie is to look at what is doing badly, why and whether a case can then be made for it. And right now, the data makes it clear that Emerging Market (EM) equities in particular are (still falling) out of favour. This chart below shows the annual return generated in sterling terms over the last decade and then how that showing ranks relative to Developed and Frontier arenas – and Emerging Markets are coming in dead last for the third year in a row.

Emerging Market equities are underperforming again in 2015

Emerging Market equities are underperforming again in 2015

Source: Thomson Reuters Datastream

The bear case rests upon commodity price weakness, corporate indebtedness and dollar strength, a combination would some believe could lead to a repeat of 1997-98’s currency and stock market rout in Russia and Asia, especially once disappointment with Chinese growth rates is added to the mix.

The long-term bull case rests upon relatively sound sovereign balance sheets, long-term demographic trends and the fact that EMs are by no means homogenous. Some have debt problems, many do not and supporters argue China is doing the right thing, as it rebalances its economy, begins to reform and open up its financial services industry and lays the groundwork for robust future growth.

Watch Washington

In the short-term the US Federal Reserve may call the shots, at least in sentiment terms as a rate rise would probably drive the dollar higher – and regular readers will know that dollar-strength tends to work against EM assets, if history is any guide.

This is because

  • If investors can get a higher return in what is perceived to be the world’s leading risk-free asset (the dollar), via cash and rising US interest rates then they feel less inclined to take higher risks in EM and buy greenbacks instead
  • EM governments in the 1990s and now corporates in the 2000s have accumulated substantial borrowings, a lot of them in overseas currencies (namely the dollar). Any rise in interest rates makes the debts more expensive to service, especially if the local currency goes down against the dollar for good measure, as has happened in Brazil, Turkey, Mexico, Malaysia and Chile this year, to name just five nations.
  • To defend their currencies and try to retain overseas cash that is funding their debts, EM central banks are forced to raise interest rates – hurting the local economy and potentially local stock markets for good measure.

Emerging markets and the dollar have historically shown an inverse correlation

Emerging markets and the dollar have historically shown an inverse correlation

Source: Thomson Reuters Datastream

Now the Fed is again prevaricating on whether to hike borrowing costs or not, EM may enjoy some respite, after a horrid period of underperformance. Investors must first decide whether such assets fit with their individual investment goals, time horizon, target returns and appetite for risk. Risk-tolerant portfolio builders may have to accept a few more lumps and bumps, even after the recent horrid period of underperformance, but at least there is a good selection of equity (and for that matter fixed-income) funds which address the asset class.

Best performing Global Emerging Markets Equity OEICS over the past five years

OEIC ISIN Fund size £ million Annualised five-year performance Twelve-month Yield Ongoing charge Morningstar rating
First State Global Emerging Markets Sustainability B (Acc) GBP GB00B64TS998 258.2 4.9% 1.7% 1.02% *****
First State Global Emerging Markets Leaders I (Acc) USD IE00B0169N27 2,444.0 4.6% n/a 1.62% *****
First State Global Emerging Markets B  (Acc) GB0030187438 670.6 3.9% 1.5% 1.09% *****
Templeton Emerging Markets Smaller Companies W (GBP) LU0768361320 294.1 3.5% n/a 1.65% *****
St James's Global Emerging Markets (Inc) GB00B63Z0P88 661.9 3.3% 0.3% 1.99% ****

Source: Morningstar, for Global Emerging Markets Equity category.

Where more than one class of fund features only the best performer is listed.

Best performing Global Emerging Market investment trusts over the past five years

Investment Trust EPIC Market cap £ million Annualised five-year performance Dividend yield Gearing Ongoing charge * Discount to NAV Morningstar rating
Utilico Emerging Markets GBP UEM 346.5 10.2% 3.8% 5% 1.85% -9.9% n/a
Advance Frontier Markets AFMF 86.4 3.5% n/a 4% 2.68% -9.4% ***
Genesis Emerging Markets GSS 600.1 1.5% n/a 0% 1.67% -10.0% n/a
JP Morgan Global Emerging Markets Income JMG 677.3 -0.1% 5.6% 13% 1.22% -4.4% *****
Advance Developing Markets ADMF 194.9 -3.7% n/a 0% 1.12% -11.9% ***

Source: Morningstar and the AIC, for Global Emerging Markets Category. * Includes performance fee

Best performing Global Emerging Market Equity ETFs over the past five years

ETF EPIC Market cap £ million Annualised five-year performance Dividend yield Fund Ongoing Charge Morningstar rating Replication method
iShares MSCI Emerging Markets Small Cap USD IEMS 155.1 -2.3% 2.0% 0.74% **** Physical
iShares MSCI Emerging Markets (Acc) USD IEMA 164.5 -3.3% n/a 0.68% *** Physical
db x-trackers MSCI Emerging Markets 1C GBP XMEM 758.9 -3.6% n/a 0.65% *** Synthetic
Source MSCI Emerging Markets MXFS 101.0 -3.7% n/a 0.45% *** Synthetic
PowerShares FTSE RAFI Emerging Markets PRSM 4.4 -8.2% n/a 0.65% ** Physical

Source: Morningstar, for Commodities Broad Basket category, as of 16 June 2015

Where more than one class of fund features only the best performer is listed.

Best performing Global Emerging Markets Bond OEICS over the past five years

OEIC ISIN Fund size £ million Annualised five-year performance Twelve-month Yield Ongoing charge Morningstar rating
Wellington Opportunistic Emerging Markets Debt IE00B3DJ3G15 1,064.9 5.3% 6.1% 0.63% *****
Goldman Sachs Growth & Em LU0129914015 3,778.4 5.1% 4.5% 0.94% *****
MFS Meridian Emerging Markets Debt Il (Acc) GBP LU219434957 2,609.0 5.0% n/a 0.86% ****
M&G Emerging Markets Bond I (Net Inc) GB00B4TL2D89 121.8 3.7% 5.2% 0.95% ****
Morgan Stanley Emerging Markets Debt Z (Acc) LU03060479504 164.2 3.6% n/a 1.09% ***

Source: Morningstar, for Global Emerging Markets Bond category.

Where more than one class of fund features only the best performer is listed.

Home Front

Alternatively, Emerging Markets can be addressed via stocks listed and traded in London. Miners used to be the market’s preferred proxy for Emerging Market growth, as did export-driven industrials, but the lustre has long since worn off this story, especially as China’s short-term outlook seemingly raises as many questions as it answers.

UK-listed mining firms have followed EM equities lower

UK-listed mining firms have followed EM equities lower

Source: Thomson Reuters Datastream

One alternative is to look at other industries and firms with exposure to EM and two leading fund managers’ names spring to mind. Aberdeen Asset Management has a strong tradition of putting money to work in Asia in particular, while Ashmore is equally powerful in EM debt markets. Both stocks have massively outperformed EM over the past few years, perhaps riding long-term demographic trends in the West which point to the need for greater saving, but if EM assets start to rise again, then history would suggest both firms could potentially benefit, in terms of stock market sentiment and the performance of their underlying business.

Aberdeen Asset Management has a rich tradition of investing in Asia in particular

Aberdeen Asset Management has a rich tradition of investing in Asia in particular

Source: Thomson Reuters Datastream

Ashmore has built a powerful franchise in EM debt markets

Ashmore has built a powerful franchise in EM debt markets

Source: Thomson Reuters Datastream

Russ Mould

AJ Bell Investment Director


russmould's picture
Written by:
Russ Mould

Russ Mould has 28 years' experience of the capital markets. He started at Scottish Equitable in 1991 as a fund manager and in 1993 he joined SG Warburg, now part of UBS investment bank, where he worked as equity analyst covering the technology sector for 12 years. Russ joined Shares in November 2005 as technology correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media by AJ Bell Group, he was appointed AJ Bell’s Investment Director in summer 2013.