Martin Gray, who runs the Miton funds range at management group Midas, has an especially amusing way of spotting emerging markets bubbles: he likes to count how many new specialist funds are being marketed to investors. In the months before the last emerging markets crash, for example, Gray noticed a growing number of country-specific and small-cap funds, all of which had vanished from view by the end of the 1990s.

So, with this warning in mind, I am treating the spate of new emerging markets funds with caution. In recent times, US providers of exchange traded funds (ETFs) have been pushing out new emerging markets trackers with gay abandon. Take the latest upstart, Global X. It has just brought out not one but six different China super-sector ETFs, plus a Columbia ETF that competes with the Van Eck Market Vector Latin
American Small Caps ETF.

I think adventurous types might be better off looking at two new UK funds that take a different approach: breaking down emerging markets into distinct themes, based on sectors and investment style. Advance Emerging Capital is focusing on small- to mid-caps in Brazil, through a hook-up with a local manager called Leblon, while Jupiter has a new fund investing in Chinese mid-to small-caps involved in infrastructure.

Until recently, most investors have been able to profit from macroeconomic trends in emerging markets quite easily – by buying a big emerging markets or Bric (Brazil, Russia, India and China) fund and benefiting from the long-term trend, plus short-term
cyclical (usually resource- related) bounces. Most of these funds held shares
in mega-cap companies in a highly concentrated fashion – Gazprom and Lukoil in Russia, Petrobras and Vale in Brazil, huge state-owned companies in banking, insurance and telecoms in China.

But as the investing herd moves into the most liquid stocks with strongest momentum, other stocks start to suffer due to inter-related market inefficiencies. Small-caps are ignored and value stocks also tend to fall off the radar, in both cases producing extra
potential for return, sometimes for both reasons (eg small-cap value stocks).

Already, the Bric markets are showing greater dispersion of returns (Russia is the chief loser, with Brazil the chief winner) and investors are starting to wonder why they’re paying top dollar for Petrobras rather than a bargain price for the guys supplying it with drilling technology.

Eventually, these investors start to try to diversify into what they can understand and invest in locally. In Brazil, that means small- to mid-caps with decent valuations. In China, it means investment in both “hard” (physical transportation and energy) and “soft” (health and education) infrastructure.

With both the Jupiter and Advance/Leblon funds, you can play these themes via concentrated, stock-picking portfolios – as few as 17 stocks in the Leblon fund.

That introduces the potential to earn extra return – in both Brazil
and China the small- to mid-cap listed sector is growing fast. Of course, that also makes these funds higher-risk, but more likely to represent overlooked value-investing opportunities.

For example, Chinese mobile phone companies may look very sexy but every day a new company emerges with private-equity backing, pushing margins down over the long term. That means you need to focus your investment on sectors where company managers want to realise inherent value (say intellectual capital) or exploit a competitive advantage built around regulatory privilege or consumer demand.

By making focused bets like this, both funds have a good chance of outperforming wider emerging markets over the next few years – although I should warn you that they are only for the ultra-long-term adventurous investor willing to put a small percentage of a portfolio into such an obviously risky investment.

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