- To back struggling markets that could benefit from the deployment of coronavirus vaccines you could tilt from Asia to the emerging markets
- Some funds offer exposure to Latin America and Russia, but these are risky trades
Those who expect a vaccine to keep driving hefty gains for last year’s stock market losers could do worse than look to the emerging markets. While the MSCI Emerging Markets index performed strongly in 2020, much of this stems from its heavy weightings to China, Taiwan and South Korea. These three markets, which made up around two-thirds of the index at the end of 2020, each delivered sterling total returns of between 26 and 40 per cent last year.
Yet plenty of emerging markets have had a much worse time of it, and look set for a potential recovery as the world slowly moves out of the coronavirus crisis. Brazil has had an especially severe pandemic, with the country recording some 217,000 deaths as of late January. India and Mexico have had their own severe outbreaks. Russia, meanwhile, could benefit not only from an eventual containment of the virus but also from a recovery in oil prices.
These markets have already staged an extensive recovery in late 2020, driven by positive vaccine news. Yet more could come – something driven both by renewed economic activity and other factors that tend to benefit emerging markets. Weakness in the US dollar, something that has materialised in recent months and is tipped to continue, is generally extremely positive for the region. A boost in inflation and even the prospect of a strong year for commodities could also prove useful.
On the other side of the equation, the likes of Chinese equities might lose some of their previous momentum as investors turn away from secular growth plays, such as China’s tech majors, and favour cyclical shares and sectors. In sterling terms, the MSCI China index was broadly flat in the final two months of 2020m, having delivered a 25 per cent return in the first 10 months of the year.
Research company Capital Economics recently argued that Chinese stocks could falter for several reasons, from an “unwinding” of support for the likes of tech stocks to a financial decoupling from the US and any renewed trade tensions between the world’s two biggest economies. Analysts at the firm also warned that an antitrust push in China would target some of its best stock market performers, while efforts to rein in the leverage of property developers “risk provoking a slump in that sector which could spill over elsewhere, particularly to the banks which finance it”.
Any rotation from the leading Asian nations to emerging markets hit hardest by the pandemic could offer rewards, but the risks are not small. As with US tech stocks, the likes of Alibaba (HK:9988) could continue to perform strongly for several years even as specialists predict the opposite. Meanwhile, economies such as Brazil and Russia are not guaranteed to recover rapidly and face plenty of challenges, from a continued struggle with Covid-19 to the demands of eventually reopening their economies.
Some 'bombed out' markets such as Brazil's are in fact roughly at their pre-Covid levels now – raising questions about how much more recovery is due. As Darius McDermott, managing director of research company FundCalibre, notes: “It takes a brave person to be contrarian and overweight those areas that lagged, like Latin America”.
With this in mind, active emerging market funds lend themselves well to any rotation. They can move beyond the benchmark weightings without betting too much on one specific region – limiting the risks to an extent. While single-country funds are one option alongside those with a focus on just a single region such as Latin America, using these comes with greater risk.
As shown in the second chart, the main emerging market and Asian indices tend to have much in common, including a large weighting to China, but the likes of Latin America and Russia are present in the former. They only make up a small weighting for indices and the passive funds that track them, but active managers can and do take bigger bets.
Funds that might fit
Funds that completely avoid the market leaders, such as Tencent (HK:0700), Samsung (KR:005930) and Taiwan Semiconductor Manufacturing Company (TW:2230), are rare to find – and doing so may be foolhardy. But there are broad emerging markets funds that offer some exposure to troubled markets.
Rob Morgan, pensions and investments analyst at Charles Stanley, favours Lazard Emerging Markets (GB00B24F1G74), a portfolio that has “a decent amount of economically sensitive exposure and looks completely different to the growth-orientated funds and trusts”. The investment team has a value bias, with a preference for companies where performance is improving and not yet appreciated by the wider market.
The fund had 10.8 per cent of its assets in emerging Europe at the end of December, with 10.6 per cent in Latin America. The fund’s top 10 holdings at the time included Russia’s Sberbank (RUS:SBER) and Mexico’s America Movil (MEX:AMXL). The fund also has a significant allocation to Asia.
Mr McDermott favours FSSA Global Emerging Markets Focus (GB00BZ8GV678). This fund backs quality companies rather than anything particularly cyclical, but offers exposure to some markets that may benefit from an economic reopening, from India to Mexico, Indonesia, Argentina and Peru.
Some others also take big stakes on beaten-up regions. Somerset Emerging Markets Dividend Growth (GB00B4QKMK51) looks notably different to some other emerging market funds, with decent weightings to both Brazil and Russia at the end of 2020 and very low exposure to China compared with the index.
Mobius Investment Trust (MMIT) has had its own share of exposure to troubled markets, with big weightings to India and Brazil at the end of 2020. However, this trust relies heavily on the success of its stockpicking process: the portfolio consisted of just 31 holdings at the end of last year. Managers Mark Mobius and Carlos Hardenberg look for "resilient business models which are undervalued and underpriced", with an onus on engaging with companies that could improve their ESG standards.
Frontier market funds are a targeted way to focus on less developed markets which often carry a higher risk/reward profile. One name from the IC Top 100 Funds that we recently analysed is BlackRock Frontiers Investment Trust (BRFI). This is not the only option: Jupiter Emerging & Frontier Income Trust (JEFI) provides a spread of different exposures, taking in many of the more beaten-up markets of 2020.
