Buy the best EM companies via Federated Hermes Global Emerging Markets

Despite emerging economy stock markets tending to include more cyclically sensitive companies that rely on purchases from the developed world, as a whole they have been very resilient since the outbreak of the pandemic. Over the year to 8 March 2021, MSCI Emerging Markets index rose 31 per cent, in line with MSCI USA index and ahead of MSCI World index, which increased by 25 per cent, according to FactSet. 

The main driver of MSCI Emerging Markets' strong performance has been China, with large consumer conglomerates Tencent (HK:0700), Alibaba (HK:9988) and Meituan Dianping (HK:3690) dominating the index and experiencing huge gains as demand for their internet services soared. However, over the past month sentiment appears to have turned, with the Chinese index down 11 per cent and MSCI Emerging Markets down 6 per cent.      

To get broad emerging markets exposure, Federated Hermes Global Emerging Markets Fund (IE00B3DJ5K90) is a popular option with a strong record. Its lead manager, Kunjal, Gala looks for “high-quality, efficient and sustainable companies”. Gala says his focus remains on long-term, structural drivers of growth such as “the roll-out of 5G networks, application of the internet of things, rising financial penetration, healthcare and infrastructure development, and growing consumer appetite for premium products. We favour quality operating companies in these fields."

A significant proportion of the fund is invested in China – 36 per cent at the end of January – although this is the fund’s largest underweight position compared with MSCI Emerging Markets index. The fund’s largest overweight position is India, in which it had 12.4 per cent of its assets at the end of January, although its management team invests via a 'bottom up' approach, focusing on companies' individual attributes and aiming to find “quality companies trading at attractive valuations”.

The fund’s largest holding at the end of January was Samsung Electronics (KR:005930), which has had a strong run since the outbreak of the pandemic, increasing 45 per cent over the year to 8 March. The stock has a forward price/earnings ratio of 14.6 according to FactSet, making it less richly valued than some technology and internet stocks listed in the region. 

Taiwan Semiconductor Manufacturing Company (TAI:2330), the world’s biggest chip foundry, is another large holding. The company announced in January that it expects to invest up to $28bn (£20.19bn) in capital expenditure in 2021, compared with $17bn in 2020, as it aims to boost production to meet demand. “In 2021, high-performance computing will become a new growth driver coming from big customers in a variety of market segments... another factor driving confidence is that 5 nanometer demand is stronger than expected,” says research company Morningstar.  

Alibaba and Tencent are two other major holdings. While Alibaba’s share price has been weak since it peaked at the end of October last year, shortly before the flotation of its sister company Ant Group was pulled by the Chinese authorities, most analysts are positive on its growth prospects. Alibaba's forward price/earnings ratio is 19.6 times, according to FactSet, compared with 58.7 times for US e-commerce giant Amazon (US:AMZN) .    

Federated Hermes Global Emerging Markets’ largest sector position at the end of January was information technology, making up a quarter of the fund. Financials was the second largest, accounting for 20 per cent. Consumer discretionary was the fund’s largest underweight position compared with its benchmark at 14 per cent of assets, while communication services and industrials accounted for 12 and 11 per cent, respectively. So while the fund is positioned for growth, it also has significant exposure to more cyclical parts of the market.   

Federated Hermes also has a long-term focus on socially responsible investing. While emerging markets are notoriously difficult for ethically-minded investors to navigate, the importance that this asset manager places on stewardship and sustainability may provide some reassurance. It assigns an environmental, social and governance (ESG) score to every company it invests in, using data from third-party providers and its own research team. And it only invests in companies with low ESG scores if they show a willingness to improve.

Federated Hermes Global Emerging Markets is not labelled as an ethical fund although its investment policy states that it will not invest in arms manufacturing. And the fund has not managed to totally avoid companies about which questions have been raised. For example, it held NMC Healthcare in January 2019 when research company Muddy Waters alleged that this company's board had misled investors over its debt levels and had poor governance structures. NMC Healthcare was the largest private healthcare provider in the United Arab Emirates, but went into administration last year. 

Federated Hermes Global Emerging Markets' investment philosophy, which focuses on growth, has provided a strong tailwind in recent years and led to impressive performance. “However, any style will have periods where it doesn’t perform [well] and it could be that we have entered one of those periods,” says Adrian Lowcock, head of personal investing at Willis Owen. But “longer-term the focus on structural change and innovation should help drive growth of the fund, while the focus on quality and, in particular, the margin of safety process within the stock analysis should mean that it is well placed to protect investors' capital from excessive valuations and avoid the traps.”

A rotation into more cyclical stocks could prove to be a harder environment for the fund in the near term. And its size – $7.5bn (5.4bn) on 8 March – has also caused some concern among fund selectors. Wealth manager Charles Stanley, for example, downgraded the fund in June 2019 because it had historically invested in small and mid-caps, but its growing size means that it is now focused on large-caps. 

If you want exposure to emerging markets smaller companies, you could invest in Federated Hermes Global Emerging Markets SMID Equity (IE00BFZNVF02). This fund launched in October 2018 and has the same managers as Federated Hermes Global Emerging Markets.

Federated Hermes Global Emerging Markets is relatively expensive for a large-cap fund with an ongoing charge of 1.1 per cent. Rival BNY Mellon Global Emerging Markets (GB00BVRZK937), for example, has an ongoing charge of 0.84 per cent and JPMorgan Emerging Markets Investment Trust (JMG) has an ongoing charge of 0.94 per cent. 

Last year Gary Greenberg stepped back from the day-to-day running of Federated Hermes Global Emerging Markets and Gala replaced him as lead manager in September 2020.

However, Gala has been co-manager of the fund since 2016 and worked closely with Greenberg for the past eight years. Greenberg will continue to oversee the team until his planned retirement in 2022. The manager succession appears to have been well handled and the eight-person team running the fund is well respected. The fund also has an established and repeatable investment process.

Emerging markets, meanwhile, generally look attractive given the structural growth available and potential continued weakness of the US dollar. So Federated Hermes Global Emerging Markets still looks like a sensible way to access some of this region’s best large companies.