In this issue, Dewi John casts his eye over emerging markets funds
The idea that emerging markets are dominated by low-value production is now widely regarded as ludicrous. China is striving to move up the value chain, as are many others.
During the second half of 2021, an ever-increasing amount of the world’s important stuff (technical term) will be produced in emerging markets, from Korean electronics to shoes from Ethiopia.
Many funds give exposure to commodity-producing countries such as Russia and Brazil. These have been tipped to benefit from the post-pandemic take-off in demand – although the optimism of early 2021 that this was nigh has dampened as the Delta variant has wreaked further havoc across the globe.
Emerging markets also thrive when the US dollar is weak. Massive money printing and a huge fiscal deficit in the US would suggest this is the likely environment for the coming period.
Nevertheless, they have struggled in relative terms in the past year. Emerging market funds often have more of a growth profile – certainly when compared to a strongly value-biased UK market. Value rallied strongly last autumn, with growth lagging. However, that looks to have reversed since mid-May, which may work to the sector’s benefit.
Investors need to consider the shifting sands of geopolitical trends. This may lack the histrionics of the Trump years but China has long been a bipartisan issue for US administrations and trade tensions did not disappear as the removal trucks took the long drive from the White House to Mar-a-Lago.
Indian regulators have moved against Chinese investors in its tech companies because of rising tensions between the world’s two most populous countries. And of course, the Chinese government has clipped the wings of its own tech sector, most recently requiring companies with the data of more than one million users to pass a security review before issuing shares on overseas stock exchanges.
Of course, emerging markets are not just Asia. There is also South America and Africa. “Brazil is the country of the future; and always will be,” Charles de Gaulle, former president of France, once said. That continues to be the case, as the fifth-largest country in the MSCI EM index heads towards another election, with Latin America’s largest economy looking likely, under a resurgent Luiz Inácio Lula da Silva, to follow Peru’s recent tack to the left.
However, while there is significant geopolitical risk, volatility is lower than you might think. The sector’s one-year standard deviation is marginally more than the USD Government Bond sector average – 2.98 and 2.79, respectively. There’s a significant spread within this but you are generally taking less risk than with a developed market smaller company fund, for example.
For five years, the sector has lagged North America and Asia-Pacific excluding Japan (returning 75.8% v 110.8% and 83.3%, respectively) but led other equity regions and UK All Companies. It is a similar story over three years, though UK All Companies comes in strong over one year. The sector struggled in relative terms during the three months to the end of June, lagging Europe, though ahead of Asia-Pacific.
Three-year returns for the sector’s funds range between 70.5% and -9.5%, with an average of 31.8% – so, as ever, fund selection matters.
The top-performing funds over three years have China as their biggest country weight – unsurprising, considering it is 37.5% of the MSCI EM index (see table). Weightings vary from 30% to 45%, however, and after this it is largely India and South Korea jostling for second and third places – the exception being the Aubrey fund, which runs China (at 44.7%, the largest overweight of the top five funds), India (35.2%, more than a 25-percentage-point overweight) and Brazil (trailing at 7.9%, but still overweight its benchmark).
Aubrey’s top holdings point to the increase of the online emerging market consumer. Top holding, Singapore-listed Sea Ltd, specialises in mobile-connected consumers in southeast Asia, with three main businesses – online gamer Garena, e-commerce platform Shopee and payment platform SeaMoney – capitalising on the region’s belated move online, compared to many other parts of Asia. Shopee concentrates on areas such as cosmetics, jewellery and fashion – profitable high-frequency purchases that are the sweetspot of online shopping in the region.
Next is Li-Ning Company, a Chinese sportswear and equipment company, which has increased almost 280% during the year. Third-placed Apollo Hospitals Enterprise is an Indian healthcare provider and has increased 160% in the past year – so, at 4% of the portfolio, is also a significant performance driver. Previous top-10 holding Info Edge also caught my eye, described as “India’s premier online classifieds company in recruitment, matrimony, real estate, education and related services”. The ultimate one-stop shop.
While these funds contain a diverse selection of global businesses – an advantage of the sector – what’s noticeable about these is that they are focused on local markets, something likely to be a growing trend.
Finally, it’s worth noting that14 exchange-traded funds have been added to the sector from April. These include the iShares MSCI EM Small Cap UCITS ETF US, and iShares MSCI EM SRI UCITS ETF USD (second and sixth over one year).
The first of these has the highest return over three months, reflecting the strong run of smaller companies over the period and beyond. These include income, EM infrastructure, ESG and low-volatility strategies, so are going well beyond tracking a basic index.
Dewi John is head of research for Refinitiv
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