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Don't give up on emerging markets

The International Monetary Fund is labelling emerging markets as the next big crisis. But here's why you should see the sunny side
November 5, 2015

Can emerging markets - and your investments in them - take any more bad news? If a much anticipated US rate rise happens before 2016, they might have to. But is this a crisis or a crash? A rise in interest rates would heap more pain on top of pain for many emerging markets, which have spent half the year reeling after being hit by Chinese growth slowdown, the plummeting oil price, the strengthening dollar and currency wars across the world.

Even if times were looking good for emerging markets, the quantity of cheap borrowing they took on during the period of record low rates would be a sticky issue. Now, with things already bleak, a rate rise could prove even stickier.

That is certainly the view of the International Monetary Fund (IMF). Last month it issued a gloomy missive, warning that a US rate rise could trigger mass defaults across the emerging world and trigger chaos across markets. Next, Andrew Haldane, chief economist at the Bank of England, weighed in, arguing that an emerging market meltdown could well be part three in a miserable trilogy that began with the recession of 2008 and continued with the recent eurozone crisis.

But we have been here before. Emerging markets have crashed disastrously and bounced back to make stellar returns. And bad news for one country is not necessarily bad news for all. For example, although the MSCI Emerging Markets Index had fallen by around 13.5 per cent between the start of the year and 28 September 2015, the National Stock Exchange of India had risen by more than 38 per cent over the same period.

"Emerging markets go through long periods of popularity and then long periods where they're out of vogue," says Adrian Lowcock, head of investing at AXA Wealth. "Right now we're in a period where nothing happening in the world is good for emerging markets and you're getting wave after wave of bad news. You've got China coming out with bad data, which will hurt Asia particularly, the commodities sell-off will affect Russia and Brazil, and the oil price collapse is bad news, too."

But he adds: "Emerging markets still have a colossal amount of potential. You are talking about large population sizes, for example Indonesia has the same population as America. The demographics in some of these countries are also very good and there is real political change happening across emerging markets, too. So from an investing perspective I don't think you should shun emerging markets, but you do have to take a long-term perspective."

"There are positives in the negatives," adds Peter Lowman, chief investment officer at wealth manager Investment Quorum. "Just think about oil at $40 a barrel. The losers are the exporters such as Russia, but cheap oil is great news for importers. When you look at historic valuations there seem to be some openings, and although we are not necessarily rushing in to buy, there are some very cheap markets relative to the world because of this crash."

For similar reasons, Mr Lowcock says: "This is where an active manager can add more value over the long and medium term because they will be able to avoid the more obvious traps."

 

Broad-based emerging funds

JPMorgan Global Emerging Markets Income* (JEMI) homes in on dividend-paying stocks across developing nations, which means it could offer lower risk than its peers over the long term. The trust invests in stocks with sustainable dividends based on payout ratios, in order to ensure the focus is on stocks paying out large amounts relative to earnings rather than those paying out unsustainable amounts of their revenue.

"By investing in companies that produce a dividend you would hope to get exposure to more shareholder-focused companies delivering a positive cash flow," says Mr Lowcock. "As an investor in the trust, if you reinvest that dividend you are also getting paid to wait. The trust has a high yield of 5.1 per cent, above the average 2.3 per cent for global emerging market trusts, and has also delivered capital growth over the long term.

He also likes Fidelity Emerging Markets Fund (GB00B9SMK778). "It's a concentrated bet that tends to focus on three market areas: emerging Asia, Europe, Middle East and Africa, and Latin America," he says. "And it focuses very much on good valuations and quality stocks."

The fund has 19.7 per cent of its assets in Africa, 4.5 per cent in Latin America and over 60 per cent in emerging and developed Asia.

Of the closed-ended funds invested in emerging markets, the top performer over five years, according to the Association of Investment Companies (AIC), is Utilico Emerging Markets* (UEM), which it says would have returned £123.9 on £100 invested over that period. The trust invests in infrastructure, utilities and related sectors mainly in emerging markets, and aims to reduce risk by selecting vital companies and sectors with niche market positions.

 

Performance of broad emerging markets funds and trusts

FundCategoryTotal return 29.10.14 to 28.10.153-year cumulative return (%)5-year cumulative return (%)10-year cumulative return (%)
JPMorgan Global Emerging Markets Income (JEMI)Global Emerging Markets-15.1-5.64.2--
Fidelity Emerging Markets fund (GB00B9SMK778)Emerging Markets Equity11.634.436.0-
Utilico Emerging Markets (UEM)Global Emerging Markets-6.714.023.9129.2
Index: MSCI Emerging Markets na2.39.210.996.9

Source: Morningstar, as at 30 October 2015

 

Being selective and looking east

But with so many countries in turmoil, picking a region or country might be a better - if more concentrated - bet. "I think it's about being selective with countries and companies," says Mr Lowcock. "You've got to be wary of countries such as Brazil, with its commodity exposure, and Turkey where you have high levels of dollar-denominated debt."

"Looking at the historic averages, there are areas that stand out in terms of value," adds Mr Lowman. "Korea, Taiwan and even China stand out, even though the latter has issues."

Mr Lowman says he is enthusiastic about the Association of Southeast Asian Nations (ASEAN) over the long term. "We like the ASEAN economies. They have been hurt quite badly recently, but have the potential for more than single-digit growth in the future. These are the new Chinas," he says, citing Vietnam as an example.

The ASEAN nations are: Vietnam, Thailand, Singapore, Philippines, Myanmar, Malaysia, Lao PDR, Indonesia, Cambodia and Brunei Darussalam.

He says he has recently been buying Barings Eastern Trust (GB00B85JKH42) and is also invested in BlackRock Asia Special Situations (GB00BJGZZ065) and BlackRock Asia (GB00B7VS8S56), depending on the risk level of client portfolios. He says the tactic is "an overlap between emerging markets and Asia".

Alex Wolf, emerging markets economist at Standard Life, also highlights Vietnam as a beneficiary of a new multi-lateral agreement, the Trans-Pacific Partnership (TPP). He says: "Vietnam is a beneficiary of TTIP and the country has made some reforms in opening up new industries to foreign direct investment. As it looks to implement some of the provisions in the trade agreement over time the outlook for the country will improve too."

Emily Whiting, investment specialist at JPMorgan Global Emerging Markets Income Trust, says: "In the past couple of years we've seen far more differentiation across emerging markets. The same can be said about a strong dollar as with oil - there are certain markets that are more affected than others. Markets with current account surpluses, most Asian markets for example, are far better insulated than others."

Those include Taiwan and Indonesia, which also benefit from youthful populations set to stimulate growth in the future.

 

Performane of Asian funds

CategoryTotal return 29.10.14 to 28.10.153-year cumulative return (%)5-year cumulative return (%)10-year cumulative return (%)
Barings Eastern Trust (GB00B85JKH42) Asia ex-Japan Equity18.638.638.4142.6
BlackRock Asia Special Situations (GB00BJGZZ065) Asia ex-Japan Equity20.020.0--
BlackRock Asia (GB00B7VS8S56)Asia ex-Japan Equity10.010.0--

Source: Morningstar, as at 30 October 2015

 

Investing in India

Of all emerging markets India still tends to be the favourite among advisers and analysts. Mr Lowman says he likes the country as a less correlated market which is benefiting from a low oil price and political change, although it is not cheap. "We have had exposure to India for a couple of years," he says. "It is something we include in more aggressive portfolios. We like Franklin India (LU0768358961) and Fidelity India Focus (LU0457960192). Their managers have always done very well at stock picking and sector picking.

"Investing in India is like investing in Japan in many ways. A lot of it is about a newly elected leader promising huge structural reforms. There is a lot of faith and markets have gone up a fair bit, so it's not a cheap market and requires a bit of a leap of faith. It could easily be the biggest economy in the world but could easily fall apart quite quickly too."

Juliet Schooling-Latter, research director at Chelsea Financial Services, agrees: "India is one of my favourite areas. I think it has a great long-term story because it has strong demographics, is not a big commodity producer and benefits from the low oil price."

She likes GS India Equity Income portfolio (LU0858290173), one of the best-performing open-ended funds invested in India since the election of reformist prime minister Narendra Modi. The best-performing fund has been Matthews Asia -India (LU0594557455), which has returned 37 per cent since Narendra Modi's election as prime minister.

Among closed-ended Indian investment trusts, Paul Taylor, managing director at McCarthy Taylor, likes JPMorgan Indian Investment Trust (JII), currently trading on a 10.3 per cent discount. He says: "Emerging markets are highly vulnerable to the strong dollar, interest rate rises and slower economic growth. This trio of risks is deterring investors from entering the sector. However, we feel a more country-specific strategy is more prudent than using more emerging markets funds."

 

Performance of India funds

Fund name CategoryTotal return 29.10.14 to 28.10.153-year cumulative return (%)5-year cumulative return (%)10-year cumulative return (%)
Franklin India (LU0768358961) India Equity19.566.144.9255.3
Fidelity India Focus (LU0457960192)India Equity18.357.437.3-
GS India Equity Income portfolio (LU0858290173)India Equity29.429.4--
JPMorgan Indian Investment Trust (JII)Country Specialists: Asia Pacific14.843.97.8170.4
Index: MSCI India na12.441.617.7147.0

Source: Morningstar, as at 30 October 2015

 

Performance of Investment Association funds invested in India

FundSince Modi in office% of fund in India
Matthews Asia - India (LU0594557455)37.4590.4
JGF-Jupiter - India Select (LU0329071053)36.899.69
First State - Indian Subcontinent (GB00B1FXTF86)34.8582.2
Invesco - India Equity (LU0267983889)33.9197.9
Jupiter - India Acc (GB00B2NHJ040)33.6795.28
GS - India Equity Portfolio Base (LU0333810181)32.697.21
JOHCM - Asia ex Japan Small and Mid Cap (IE00B6R5YM91) 30.9430.5
Fidelity - Global Health Care A (LU0261952419)27.591.3
Aberdeen Global - Indian Equity D2 (LU0231462077)27.0499.6
BlackRock - GF India A4RF (LU0250163515)26.7796.51

*Share classes may not be appropriate for retail investors, Source: Trustnet, from 26 May 2014 to 27 Oct 2015, Currency: pounds sterling

 

Shares I Love

Emily Whiting, investment specialist on JPMorgan Global Emerging Markets Income Trust picks three emerging markets companies that look attractive.

SILICONWARE PRECISION (2325:TAI): "We are most overweight in Taiwan and a big part of that is because of the IT companies in the semiconductor space driving consumer demand across the world. Just think about the Apple (AAPL:NSQ) supply chain and how many things we touch each day which contain some form of semiconductor. Taiwanese companies also have a good dividend culture."

LUKOIL (LKOH): "You might think why would anyone touch Russia? Considering the sanctions and ongoing tensions with Ukraine it looks horrible from a top-down perspective, but from a bottom-up view you can see companies that are incredibly cheap and have firmly committed to paying out consistent dividends. Lukoil is one of those. In February 2015 when the currency had grown incredibly volatile, the company said it would commit to paying a dividend in US dollars rather than roubles so investors wouldn't suffer."

BB SEGURIDAD PARTICIPACOES (BBSE3:SAO): "Brazil is another country that looks horrific at the minute. The real is incredibly cheap, at decade lows and politically it's an utter mess. Roussef was elected last year and her ratings are in the single digits. She's caught up in a scandal at Petrobras and their investment-grade status has been reduced. But there are some decent Brazilian companies on sale so any company that can continue to make profits in this context makes you think what must they be able to do if the market looks up? We believe (insurance company) BB Seguridade Participacoes has a secular opportunity from increased insurance penetration in Brazil, and it currently delivers a 6 per cent dividend yield."

*A member of the IC Top 100 Funds.

 

ETF INVESTING

Alan Miller, founder of SCM Private, which invests in exchange-traded funds (ETFs), says: "Now is an excellent time to invest in emerging markets.

"Outflows have slowed down considerably from emerging markets and currencies recently, and while many of these markets have various political and economic issues, this has already been factored into the price you pay. Only a small tick up in sentiment by fund managers regarding emerging markets from suicidal to gloomy would give rise to significant returns.

"My advice would be to concentrate on three, relatively plain vanilla, well-diversified ETFs with attractive valuations.

"Emerging market small-caps offer one of the cheapest ways to capture strong growth, while the Hong Kong listed China shares have been significantly derated relative to their mainland China counterparts, and currently stand on a 22 per cent discount on a like-for-like basis.

"iShares Core MSCI Emerging Markets IMI UCITS ETF (EIMI) includes many medium-sized stocks as well as the mega-caps such as Samsung. When virtually every emerging market is so lowly valued, it makes sense to invest across a broad spread of markets."

 

Mr Miller's favoured ETFs and value metrics

 Expense RatioNo. of holdingsUnderlying price/earnings of stocksUnderlying price/book of stocksUnderlying dividend yield of stocks (%)Estimated EPS growth over next 3-5 years (% pa)
iShares Core MSCI Emerging Markets (EIMI)0.25% pa1,89610.8x1.2x2.9012.5
SPDR Emerging Markets Small Cap UCITS ETF (EMSM)0.55% pa77312.3x1.1x2.7016.0
HSBC MSCI China UCITS ETF (HMCH)0.6% pa1458.8x1.2x3.4011.5
MSCI World index - -14.7x2.0x2.709.8

Source: SCM Direct