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Entering the bear's lair

Created:

1 July 2008

Written by:

Moira O'Neill

Have you looked at your portfolio's asset allocation recently? If not, then it's time to reassess your overseas exposure, particularly in the more risky emerging markets - traditionally seen as highly volatile areas of investment.

Investors' portfolios are failing to keep pace with the economic growth of emerging markets, claims Fidelity International. The company's research found that UK investors have just 2.3 per cent of their portfolios in global emerging markets, even though they now account for 30 per cent of world GDP.

The cynic in me says that the fund manager simply wants to sell more of its emerging markets funds, but the argument does seem convincing: UK investors could be missing out on some of the world's strongest economic growth because the conventions on asset allocation have failed to keep pace with world changes.

China has climbed its way up the world league table of economic growth and is forecast by the International Monetary fund (IMF) to be the third most important country in terms of GDP by the end of the year, behind Japan and the US.

But even the MSCI AC World index, one of the most popular benchmarks for international equity portfolios, has only 12 per cent exposure to emerging markets, despite seven of the world's 20-largest economies now being found in emerging markets, with Russia and Brazil also both in the top 10, according to Fidelity.

Peter Hicks, executive director of UK retail at Fidelity International, suggests advisers and investors might want to reconsider their asset allocation models.

"Now that China's economy has overtaken that of the UK, Germany and France, it is difficult to ignore the emerging markets story. But the changing economic realities make it worth rethinking traditional exposure levels," he says. "Obviously there are risks with investments in emerging markets - corporate governance standards are in some cases lower than in the west and their equity markets can be as volatile as British banking shares. But, over the longer term, the performance of stock markets tends to be correlated with economic performance."

But Mr Hicks is realistic about the level of investment most customers would be happy with. "Matching the GDP figure of 30 per cent may be too much but, for the adventurous, a 10-20 per cent weighting might be a more realistic reflection of these economies' stature," he says.

"In the long term, emerging markets will become the markets and the western world will become the emerging," says Nicholas O'Shea, director of Pharon independent financial advisers. "Anyone investing for 15 to 20 years or more has got to have some emerging markets. I would have 15 per cent myself."

Where to go

So, which emerging markets look most promising? At the country level, the F&C Investments emerging equities team favours Russia, the United Arab Emirates and Brazil and is mostly underweight China, Korea and Malaysia.

Jeff Chowdhry, head of emerging equities at F&C, says: "Despite the relative lack of exposure of many emerging countries to the worst aspects of the global credit crunch, the external environment still carries challenges from a slowdown in global growth and rising inflation."

Colin McLean and Donald Robertson, joint fund managers of SVM Global fund, also believe that Russia remains one of the most attractive markets. Of the BRIC economies (Brazil, Russia, India and China), SVM believes that Russia has the most favourable dynamics and has become, paradoxically, one of the safest markets in the world. As opposed to the conditions in 1998, Russia now has a stable political background, large current account surplus, a growing economy and is a major exporter of much sought after commodities. In addition, there is a growing will to restructure some of its ancient infrastructure and banking system. SVM holds JPMorgan Russian Securities as a core holding and recently, due to its superb performance, became the fund's largest holding.

Formed in 1994, JPMorgan Russian Securities (fund data here; registration required) still remains the sole pure Russian equity fund in the investment trust sector. Unlike many emerging market funds, the fund does not attempt to track its benchmark, preferring to take a more bottom-up approach. To this end, it focuses on domestic- rather than international-facing businesses, and on the restructuring process that is under way in Russia. This should protect the fund from the pressures being experienced elsewhere.

Top 20 economies by GDP (percentage share)