Emerging market funds have been among the best performers of the past year, with the average unit trust in the sector up more than 80 per cent since the sector bottomed out last autumn.
The surge in returns has propelled some funds above their pre-credit crisis highs, and is reviving interest in these fast-growing economies. Many emerging economies are seen as having weathered the financial crisis better than the west and better than previous downturns.
While the UK is still trying to crawl out of recession – and the US announced only this week that its economy was expanding again – China reported growth rates of nearly 9 per cent, while the Indian economy is forecast to grow by about 6 per cent in the year to March.
Even allowing for some questions over the reliability of Chinese statistics, analysts express little doubt that the emerging economies will continue to deliver growth rates far higher than those in the developed world. And this, according to conventional wisdom, should translate into better stock market performance, particularly over the longer term.
Anthony Bolton, former “star” fund manager at investment firm Fidelity, is a fan of emerging markets. Writing recently in FT Money, Bolton said: “The big question now is whether the relative growth advantage of emerging markets over the developed world has increased. I think it has – particularly for emerging markets driven by domestic demand and investment [rather than those driven by exports or commodities].”
Bolton suggested that investors should be looking to increase their portfolio weighting to emerging markets from what he said was typically 15 to 20 per cent currently.
In fact, financial advisers say, most private investors have even less in emerging markets. Tom McPhail, head of pensions research at Hargreaves Lansdown, says pension investors generally have 5 per cent or less of their overall portfolios in these markets. Holders of self-invested personal pensions might have higher allocations to emerging market funds but, in many cases, this would be offset by holdings in UK or “managed” funds in other pensions.
“Undoubtedly, most investors are underexposed to emerging markets,” says Peter Lucas at RBC Wealth Management. Emerging markets, he notes, are already about 10 per cent of world stockmarket capitalisation, but account for about a third of global GDP.
However, they are also higher risk and investors should be prepared for a potentially rollercoaster ride. Global emerging markets unit trusts fell about 50 per cent before their bounceback last autumn.
Academics at London Business School also questioned the assumption that higher growth in emerging markets will translate into better stock market returns. After analysing 100 years of data to 2009, Elroy Dimson and colleagues found no correlation between a country’s economic growth rate and its stockmarket returns. “If you buy into countries that are classified as being higher growth then you will probably overpay,” Prof Dimson warns.
RBC’s Lucas says that following the past year’s run-up in emerging markets, a price “correction” of up to about a third was possible, which could provide a better-value entry point. The price-to-book ratio of Indian stocks is about three times that of Japan, he notes. “Investors should buy on the dips,” he says.
Financial advisers also suggest dripfeeding money into emerging market funds on a regular basis to reduce risks and smooth out volatility.
Most suggest starting with a global emerging markets fund. The attraction is that managers have flexibility to take advantage of opportunities wherever they arise, rather than being restricted to a single country.
Aberdeen Emerging Markets and First State Global Emerging Market Leaders are popular choices among advisers. Both are seen as relatively defensive funds that may protect investors in more difficult markets, although this may be at the expense of some return when shares are rising strongly. Meera Patel, senior analyst at Hargreaves Lansdown, also likes Ignis Hexam Global Emerging Markets. “This is more punchy with a concentrated portfolio of holdings. It may take bigger bets on individual stocks, countries or sectors in which Bryan Collings, the manager, has the highest conviction.”
Adrian Lowcock, senior investment adviser at Bestinvest, favours other First State funds. First State Asia Pacific Leaders, he says, is run with an absolute return strategy. According to Lowcock: “The investment approach is more cautious, as manager Angus Tulloch looks for steady growth and focuses on high quality, shareholder-friendly companies. The style has provided greater downside protection while usually matching benchmarks in a rising market.” He also likes First State Greater China, which invests in mainland China, Hong Kong and Taiwan.
Mick Gilligan, head of research at investment advisers Killik & Co, looks for managers who focus on corporate governance, disciplined capital allocation and valuation. He particularly likes teams at Lazard and First State, where he tips Lazard Emerging Markets and First State Asia Pacific Leaders, respectively.