The key to a healthy portfolio is diversification. Different assets, geographies and investment styles will help you maintain steady returns and weather different market environments. And one way for certain types of investors to diversify their portfolios is to invest in emerging market funds
Emerging market economies have young and growing populations that are becoming wealthier and are spending more money. “The key difference between developing and developed markets is that growth is higher in the former," says Adrian Lowcock, head of personal investing at Willis Owen. "Developed markets have been more subdued since the 2008 financial crisis.”
Emerging markets are being driven by growth in population, urbanisation and gross domestic product (GDP). Ritu Vohora, investment director at M&G Investments, says that China is expected to account for 33 per cent of the world’s economic growth in 2019, with the rest of Asia a close second with 30 per cent. This compares with just 11 per cent for the US and a mere 4 per cent for the eurozone.
Global emerging market funds are likely to invest in the four biggest emerging market economies – Brazil, Russia, India and China (Brics) – which appear to have the potential for strong long-term growth.
India, for example, has potential because of a focus on infrastructure projects, and markets have responded well to the re-election of Prime Minister Modi due to his pro-business policies, such as cutting through red tape and making long-term structural changes. India is also the fastest growing Bric economy and may overtake China.
But China is making huge leaps in innovative technologies and presents tremendous opportunities due to its rapid urbanisation. “They’re building cities multiple times the size of London,” says Darius McDermott, managing director of Chelsea Financial Services. "The population’s growing middle class is demanding more consumer goods and this can be seen in the large captive audiences of Chinese multinational conglomerates Alibaba (US:BABA) and Tencent (HKG:700), which many emerging market funds have holdings in."
China’s urban expansion has also benefited Brazil, one of the biggest metal exporters. This country is coming out of a particularly deep recession, and since October has been one of the best performing emerging markets.
Craig Botham, senior emerging markets economist at asset manager Schroders, expects growth in Russia because “the economy should benefit from higher oil prices this year”. He also expects growth to pick up next year due to “planned increases in government spending on infrastructure”.
Risks as well as rewards
However, emerging markets can be volatile and although valuations are currently good this could change if macroeconomic factors change. “Political upheaval, for example, is more risky in emerging markets," says Mr Lowcock.
Emerging market currencies can also be volatile, and both boost and hinder returns. Corporate governance and treatment of shareholders tends to be of a lower standard in these countries. And if ongoing US-China trade tensions have a negative effect on exports and investment it would be likely to have a knock-on effect on retail sales and industrial production, and depress emerging market share prices.
For these reasons, Mr Lowcock recommends that you do not invest in emerging market funds unless you are an equity investor with a high tolerance for risk, and do not hold more than 10 per cent of your portfolio in emerging market funds. You should also have a minimum investment horizon of at least five years.
Funds for exposure to emerging markets
Investors with the right profile for investing in emerging markets could consider Fidelity Emerging Markets Fund (GB00B9SMK778). It aims for long-term growth by investing in companies that have strong market positions and characteristics that give them a competitive advantage in their industries. They provide the fund with attractive earnings through both the ups and downs of the economic cycle.
The fund also invests in companies that deliver superior returns on their assets and have well-capitalised balance sheets, as these are usually better placed to fund internal growth without diluting existing shareholder earnings by issuing new shares.
Its manager, Nick Price, is supported by a team of analysts with over 17 years' experience, on average, who research stocks for Fidelity’s regional emerging market portfolios focused on Asia, the Middle East and Africa, and Latin America. It is from these portfolios that Mr Price gets ideas on which stocks to pick for this fund. Fidelity Emerging Markets also has a good long-term performance record and has beaten MSCI Emerging Markets index over five years.
Lazard Emerging Markets (GB00B24F1G74) has been managed by James Donald since 2007. He is supported by a team of more than 200 investment analysts located worldwide who help to identify the global brands of tomorrow in developing regions. "Mr Donald and his team look for companies with improving financial productivity that hasn’t yet been recognised by the market,” says Mr Lowcock. "They use market volatility created by macroeconomic events to time trading opportunities.”
The fund typically invests in 70 to 90 companies and its largest sector exposures are financial services and technology. More than half of the fund is allocated to large-caps and its largest holdings are China Construction Bank (SHH:601939) and Samsung Electronics (SMSD).
First State Greater China Growth (GB0033874321) is managed by Martin Lau, who looks for well-managed businesses with good corporate governance listed in Hong Kong, China and Taiwan. Mr Lau is based in Hong Kong and has managed the fund since its inception in 2003. He selects stocks according to their own merits, rather than because of sector or macro considerations, and favours companies that deliver sustainable growth at attractive valuations. The fund had 54 holdings at the end of May 2019, most of which were large-caps. Its largest sector exposures are technology and industrials, and its biggest holdings are Taiwan Semiconductor Manufacturing (2330:TAI) and Tencent, a conglomerate that specialises in internet-related services and products.
The fund has consistently performed well and beaten its benchmark, MSCI Golden Dragon index, over one, three, five and 10 years.
Although Hiran Dasani has only been the named manager of Goldman Sachs India Equity Portfolio (LU0858290173) since 2017, he has been part of the team that runs it for 17 years. Mr Dasani favours sound companies that are trading at a lower price than their intrinsic value. To assess valuation, he and his team prioritise real cash flow over paper profits. He follows a growth-based investment process and seeks holdings largely according to their own merits, rather than sector or macro considerations, by conducting detailed research into each company, meeting them in person in India. Mr Dasani and his team look at a company's business fundamentals, corporate governance and valuation. But they also look at the attractiveness of the company’s industry and may disregard highly competitive and capital-intensive industries. The fund has over half of its assets in large-caps and its biggest holdings are Infosys (INFY:NSI) and Reliance Industries (RELIANCE:NSI).
The fund has beaten MSCI India index over five and 10 years. But because it is focused on one country, and also has exposure to medium and smaller companies, it could be more volatile than a broad global emerging markets fund.
JPMorgan Emerging Markets Income Fund (GB00B5M5KY18) is managed by Omar Negyal, Jeffrey Roskell and Amit Mehta, who are supported by JPMorgan Asset Management's wider emerging markets team. They conduct detailed fundamental analysis on the underlying qualities of businesses, and assign five-year expected total returns by looking at earnings growth, dividends, valuation multiples and currency. The fund typically invests in 50 to 80 stocks and has approximately 60 per cent of its assets in companies with a 3 to 6 per cent yield. The fund aims for income and has a yield of 3.8 per cent, but growth investors could reinvest dividends by holding the accumulation share class.
The fund mainly invests in large-caps and its largest sector weightings are financial services and technology. Its 10 largest holdings include Taiwan Semiconductor Manufacturing and Ping An Insurance (SHH:601318), a Chinese conglomerate focused on insurance, banking and financial services.
|Fund/benchmark||1 year total return (%)||3 year cumulative total return (%)||5 year cumulative total return (%)||10 year cumulative total return (%)||*Ongoing charge (%)|
|Fidelity Emerging Markets||-0.63||47.19||60.17||NA||0.96|
|Lazard Emerging Markets||1.23||41.85||29.55||112.44||1.08|
|JPM Emerging Markets Income||8.01||54.44||45.87||NA||0.9|
|MSCI Emerging Markets index||-2.09||52.04||45.59||112.63|
|IA Global Emerging Markets sector average||-0.38||46.93||42.18||101.62|
|First State Greater China Growth||-5.74||65.15||84.49||247.89||1.05|
|MSCI Golden Dragon||-7.39||60.79||80.81||161.42|
|IA China/Greater China sector average||-11.56||59.51||75.7||129.89|
|Goldman Sachs India Equity Portfolio||0.67||46.17||103.28||266.45||1.05|
|MSCI India index||11.45||54.14||76.15||131.76|
|Source: FE Analytics as at 14 June 2019, *fund providers.|