The investment promise of emerging markets is enticing: to profit from the superior growth of underdeveloped economies. But the reality can be disappointing. In the five years to the end of 2007, the MSCI Emerging Markets index nearly quintupled in value in dollar terms. However, ten years later, it still stands below the peak then reached.
There are many reasons why emerging markets (EMs) have been less rewarding than predicted. Economic growth doesn’t necessarily translate into corporate profits, which is why investment in most Chinese companies (other than a few tech giants) has been persistently disappointing. Corporate governance and corruption are a regular problem, as illustrated by Petrobras, Brazil’s scandal-hit energy company. Domestic politics, social unrest, arbitrary government intervention and fluctuations in the domestic currency add to the risk. All this was reflected in the maxim of the legendary investor Nils Taube “never to invest in a country where you didn’t need an overcoat in winter”.
If 2007 was the peak of the cycle, 2015 was the bottom. The optimism of 2003-2007 had dissipated, commodity prices had plunged, currencies collapsed and political and economic uncertainty was rife. Then in 2016, as politics stabilised while commodity prices and currencies rallied, EMs recovered, only to suffer a setback when the dollar strengthened.
EM currencies may not be cheap against sterling (not much is), but they are cheap against the dollar. Economic growth is picking up, corporate managements have had sense knocked into them and valuations are reasonable. The MSCI Emerging Markets index trades on barely 12 times 2017 earnings – a 20% discount to the world index.
That said, the index has a curious composition. Asia accounts for 70%, while everywhere else, including eastern Europe, Latin America and Africa, is just 30%. Seven of the top ten constituents are Chinese, while the others are based in South Korea or Taiwan – which are hardly emerging countries any more. The index also excludes so-called frontier markets such as Argentina, Nigeria and Vietnam.
This argues against investing in passive funds. Instead, a broad-based EM fund is the best starting place for investors, perhaps supplemented by regional, country, specialist or frontier funds. There are three large investment trusts to choose from, each of which is focused on companies rather than countries and is prepared to diverge significantly from the benchmark. They are all liquid, with assets close to £1bn, and trade at a discount to net asset value of 12%-14%.
JPMorgan Emerging Markets Investment Trust (LSE: JMG) has the best performance record, returning 52% and 42% over three and five years. The focus is on quality growth companies. (The same team also manages the smaller £400m JPMorgan Global Emerging Markets Income Trust (LSE: JEMI), which yields nearly 4% and has a better one-year record.)
Templeton Emerging Markets Investment Trust (LSE: TEM) was the laggard of the three, until Carlos Hardenberg came on board in late 2015. In the past year, a return of 61% was the best of the three, helped by a move away from the “cheap” lame ducks which had peppered the portfolio.
The performance of Genesis Emerging Markets Fund (LSE: GSS) lies in the middle, but the investment approach is attractive. The management firm is a partnership focused on emerging markets rather than a small part of a corporate empire. Their larger open-ended fund is closed to further money, which funnels all new investors into the trust. This may be the tortoise that wins the long-term race.
In the news this week…
Standard Life, the UK’s fourth-largest insurance and investment group, will acquire the independent fund management group Aberdeen Asset Management for £3.8bn, in a deal that will create the UK’s largest asset manager (see page 8). The combined group, which will be headquartered in Scotland, will be responsible for £660bn in assets under management. Shares in both companies were up almost 6% on the day that the merger was announced. The deal will complete Standard Life’s evolution from a traditional insurer into an asset manager, while letting Aberdeen reduce its heavy dependence on its volatile Asian and emerging-market equity funds, which have experienced large outflows in recent years.
If you have money invested in some of the 114 funds run by the two firms, you are likely to see any similar funds merged, with the most successful managers left in charge and the less successful ones pushed out, says Aime Williams in the Financial Times. This is “good news” for most investors, Darius McDermott of the consultants Chelsea Financial tells Williams. “If you’re in an Aberdeen or Standard Life fund that is doing badly, you’ll be merged into a better fund.” However, the enlarged funds may find it harder to outperform the market in future, especially in smaller and illiquid asset classes. The merger should probably allow the two bodies to save money on marketing and administration, but it’s unlikely that the company will cut management fees on its funds if it can avoid doing so.
A “rookie activist investor” has succeeded in installing a 72-year-old “industry maverick” as chief executive of CSX, one of America’s biggest railways, say Jacquie McNish and David Benoit in The Wall Street Journal. CSX said on Monday it has agreed to appoint Hunter Harrison to its board, after a two-month campaign from the activist fund Mantle Ridge. Harrison’s success turning around other railway companies has earned him “such a loyal following” that news of his ambition to run CSX led to a 23% rise in its share price in mid-January. Before negotiations were completed, CSX announced last month that it plans to lay off up to 1,000 management staff, saving at least $175m in annual costs.