IC Top 100 Funds update: BlackRock Emerging Europe

The approach seems to be working: over six months BlackRock Emerging Europe has beaten its benchmark MSCI EM Europe 10/40 Index, returning 5 per cent in contrast to -1.7 per cent for the latter.

"We want our weighting to be driven by our conviction and not be slaves to the benchmark," says co-manager David Reid. "This strategy allows us to tap into future opportunities, and in terms of our sector allocation reflect opportunities. The sector bias of our benchmark reflects companies' market cap size - not opportunities. But this is not the way we want to approach this: if you look outside the benchmark diversification is much better."

Energy comprises a large chunk of the benchmark, and together with financials and materials accounts for 76 per cent. But outside the benchmark the trust can get exposure to areas such as the internet, healthcare and infrastructure in Russia.

"We are particularly excited by the prospects for companies such as Yandex and Mailru, dominant leaders in Russia's fast-growing internet space, Dragon Oil, one of the cheapest oil companies worldwide with excellent production growth potential, and Globaltrans, a highly cash-generative railway transportation firm," says co-manager Sam Vecht.

The unconstrained investment approach also allows BlackRock Emerging Europe to access companies in areas such as pharmaceutical innovation, agriculture in Commonwealth of Independent States (CIS) countries and materials in the Eurasian region.

"We have reduced exposure to Russia because we see many opportunities in the broader CIS, for example, Ukraine," explains Mr Vecht.

Despite broader emerging markets having had a difficult time recently, Mr Vecht is positive on emerging Europe. "The emerging European region includes some of the cheapest shares in the world and many stocks in the portfolio are growing earnings at 10 to 15 per cent a year," he says. "Over the last six months emerging European markets have tended to follow the mainly negative market moves seen across global emerging markets, rather than move in tandem with their western European peers. The result is that many companies in emerging Europe are positioned to benefit from the improving economic environment yet trade on attractive valuations."

Emerging Europe offers fast growth and deep value: for example over the past 10 years earnings per share have grown 25 per cent for the MSCI Emerging Europe Index, in contrast to 19 per cent for MSCI Global Emerging Markets and only 8.6 per cent for MSCI World. MSCI Emerging Europe has a ten year average return on equity of 14.1 per cent, against 12.8 per cent for MSCI Emerging Markets and 12 per cent for MSCI World.

And MSCI Emerging Europe is at low valuations, on a price-earnings ratio of 5.8 per cent, in contrast to 10.1 per cent for MSCI Global Emerging Markets and 14.8 per cent for MSCI World.

Dividend yields are rising in emerging Europe and over the past three years have surpassed those of global emerging markets. "Dividend yields are pretty healthy and there is valuation support," says Mr Vecht. "Even if you don't believe in a re-rating you get a 4 per cent dividend yield, and over the next few years a 6 per cent yield could be possible."

He adds that emerging Europe is wrongly classed together with peripheral Europe and main Europe, but there are some very important economic differences.

"Russian and eastern European markets benefit from flexible and dynamic economies, with undervalued currencies, and educated and skilled workforces, allowing the countries of the region to remain competitive in a globalised market," says Mr Vecht. "Despite the attendant risks, valuations are still attractive given many of these risks are reflected in current prices."

If global markets have a wobble, which Mr Vecht says is due, then emerging European markets would probably also be affected. Russia in particular would be affected if there is a fall in the oil price which has been over $100 for some time. The proliferation of shale extraction could mean that the price comes under pressure.

"However, we are not a Russia fund, and Turkey is a big consumer of energy and would benefit from this," says Mr Vecht. "So we would not be stuck with nowhere to go.

"We have consistently cautioned over recent years that Turkey's current account deficit was an economic vulnerability that could be exposed by a higher global interest rate environment. With the market having fallen 40 per cent from its 2013 peak, and valuations returning to multi-year lows, Turkey is now starting to look a much more interesting place for the long-term investor. Many Turkish stocks, including leading banks like Halk Bank, are trading at close to book value or below.”

Turkey accounted for a fifth of the trust’s assets at the end of 2013.

"We have to buy when all others are very scared," continues Mr Vecht. “The key question, as always, is what’s in the price. Many investors perceive growth as a winning strategy but the reality is different. In emerging markets value has outperformed despite the focus on growth.”

Between 2002 and 30 November 2013, MSCI Emerging Markets Value returned 441 percent against 356 per cent for MSCI Emerging Markets Growth.

He adds: "Having been underweight Turkey for three years we have gone overweight. It may not correct next week or next month but buying makes sense. It will be choppy but offers compelling value and it pays to be brave when others are fearful."

Source: Morningstar

Source: Morningstar as at 27 January 2014

TOP TEN HOLDINGS as at 31 January 2013

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