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Emerging markets investment trusts are making a big comeback

It has been a remarkable 12 months for the global emerging markets with the share prices of the 11 investment trusts in the sector increasing by an average of 35.8%. This was a welcome reversal of fortunes after years of underperformance culminating in a sharp sell-off in the run up to the first increase in US interest rates in December 2015.

Analysis by Lazard Investment Management suggests that the fundamentals are improving with fewer downward revisions to consensus bottom-up earnings per share (EPS) forecasts for the companies in the MSCI Emerging Markets index.

They also point out that the decision by the US Federal Reserve to delay any further interest rate hikes in 2016 has taken the pressure off the emerging market currencies and helped the commodity exporting economies to stabilise. Many of these countries have significant levels of dollar denominated debt which is expensive to service when the dollar appreciates.

Despite the recent strong performance the global emerging markets investment trusts are still trading at an average discount to net asset value (NAV) of 11.7%, with only the Fundsmith Emerging Equities Trust, with its large retail investor base, valued at a premium.

Fresh start

Anthony Leatham, an analyst at Peel Hunt, says that whilst not a pre-requisite, some presence on the ground in the emerging markets can provide equity investors with an edge in this region, given how localised risks and opportunities can be.

‘The investment process should be clear, repeatable and differentiated – particularly as investors can now buy the emerging market story via an index tracker or ETF for a very low cost. The performance track record should be sufficiently long to be able to assess the efficacy and value-added.’

He recommends the £1.7bn Templeton Emerging Markets Investment Trust (TEM) and says that it has been just over 12 months since Carlos Hardenberg took over from Dr Mark Mobius.

‘The new lead manager brings with him 14 years of experience with the Templeton Emerging Markets Group, supported by over 50 dedicated portfolio managers and analysts across 18 offices globally. The style is fundamental stock picking with a long investment horizon and a value-bias.’

Hardenberg has made a series of portfolio changes, including a move to diversify away from the mega-caps, reducing the concentration in the largest holdings and adding frontier market exposure. These have really paid off as the fund has delivered an NAV return of 46% over 12 months, which is 9% ahead of its benchmark with the same level of risk, yet it continues to trade on a 14% discount, one of the widest in the sector.

Inv Trusts table

Active approach

Emma Bird, a research analyst at Winterflood Investment Trusts, says that an assessment of the volatility of a fund’s NAV can be particularly important for emerging markets investment trusts, due to the inherently higher risk profile of the underlying assets.

‘We believe that considerable importance should be placed on an active fund manager with experience of investing in the region as the range of companies and potential investment themes continues to increase. Investors should also consider the level of diversification, the size and secondary market liquidity of the fund and whether the manager is making use of gearing or investing in more illiquid assets.’

She recommends JPMorgan Emerging Markets (JMG), which has been managed by Austin Forey since 1994 and over the period has delivered a NAV total return of 441%, significantly outperforming the 295% returned by its MSCI Emerging Markets benchmark.

‘Forey takes a long-term investment approach and is a genuinely active manager. While this may lead to periods of underperformance compared with the benchmark, we believe that the fund’s emphasis on high quality growth companies will allow it to outperform over the long run.’

Bigger picture

Another option would be to invest in the Asia Pacific ex Japan region, which has a high degree of overlap with the emerging markets. There are 15 investment trusts operating in the sector, with Alan Brierley, director of the investment companies team at Canaccord Genuity recommending Pacific Assets (PAC).

He says that it has been just over five years since the appointment of Stewart Investors to run the fund and that this has completely transformed the performance. ‘The manager has a clear and distinct investment philosophy with long-term sustainability themes a key
driver of a bottom-up stock selection process.’

Before investing in any of these funds it is important to appreciate that the emerging markets will always be a volatile area and likely to experience sharp swings in value. There are also important risks such as political corruption and the need for structural reforms that are less of a concern in the more developed nations.

If you are uncomfortable with this you might prefer a global fund with a large allocation to the emerging markets such as Murray International (MYI), which is on the Winterflood recommended list.

The majority of the fund’s 15% fixed income exposure is in emerging market debt, consisting of corporate and sovereign bonds, denominated in both local currencies and US dollars. A further 16% of the fund is invested in Latin American and emerging market equities, with another 25% in Asia Pacific ex Japan and 1% in African equities.

‘Bruce Stout, the manager, currently views emerging markets as a more attractive place to invest than the developed markets, due to the familiarity of monetary policy conditions and the ability to attempt to predict future policy reactions and their effects,’ explains Bird.

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