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Emerging markets: good, bad and ugly

Can the best performers extend a winning streak?
December 19, 2019

From breakneck GDP growth in China to the rise of India’s middle class, investors are well versed in the case for emerging market equities. But 2019 has continued the region’s legacy as a great hope, and ultimately a great disappointment, for growth investors.

The MSCI Emerging Markets index rose by 8.5 per cent in sterling terms over the first 11 months of 2019. While that might seem impressive when viewed in isolation, it lags other markets. Major equity indices in the US, UK, Europe, Japan and Asia all made a return of between 9 and 23.4 per cent over the same period. This continues a longer-term trend: emerging markets are at the back of the pack on a 10-year timeframe. Emerging markets have only really turned heads in the bond space this year, with emerging market debt performing extremely well on the back of their attractive yields.

The case for emerging market equities has generally remained difficult to counter, but it has started to draw some prominent critics. In the 2019 edition of its Equity Gilt Study, an annual report assessing investment trends, analysts at Barclays argued that the advantages of emerging markets population growth and productivity gains might, in fact, be “significantly exaggerated”.

“A more realistic assessment that accounts for actual demography and the effects of recent technological progress implies that the underperformance of emerging market assets and currencies that began in 2013 might have a significant amount of room to run,” the analysts added.

Some emerging market countries, businesses and industries have fared vastly better than others, with the same dynamic applying to the active fund managers seeking to pick the best names. Some funds with the best returns have doubled down on a few behemoths dominating the market, but there are questions around the risks this might entail.

Table 1 shows how some of the biggest constituents of the MSCI Emerging Markets index performed in the first 11 months of this year, as reflected by the same provider’s single-country indices.

The figures, which are given in sterling terms, expose a wide disparity. The Russian index is far ahead of anything else, with a sterling return approaching nearly 40 per cent. MSCI Taiwan and China also locked in double-digit gains, while only the South Africa index fell.

Table 1: Performance of MSCI Em. Markets biggest constituents
IndexYear-to-date performance, as of 1 December 2019Country’s weighting in MSCI Emerging Markets index, as of 29 March 2019 (%)
MSCI Russia37.693.8
MSCI Taiwan2511.4
MSCI China12.2133
MSCI Brazil10.77.2
MSCI Emerging Markets8.49na
MSCI Thailand6.832.3
MSCI Mexico4.672.7
MSCI India4.049.2
MSCI Korea0.6313
MSCI South Africa-1.215.9
Sources: FE, MSCI

However, it is important to note both the sizes of the indices themselves and the size of a country’s market within this universe. MSCI Russia’s performance can vary significantly, in part because this index contains just 23 stocks, meaning big shifts in large names can easily move the dial. Gazprom (Rus:GAZP), the biggest constituent, made up nearly 19 per cent of the index at the end of November and has enjoyed healthy share price gains this year. Sberbank (Rus:SBER), the second-biggest constituent with a 17.3 per cent weighting in the index, has also seen its share price march upward.

MSCI Russia is also just a small element of the broader Emerging Markets index, a benchmark widely followed by passive funds, observers and active managers. This, and the fact that the Russian market is both volatile and vulnerable to significant political issues, means only the hardiest investors will have a huge amount of exposure.

More notably, Taiwan, China and Brazil are all big constituents of the universe that have performed better than the broader index. In the case of MSCI China, the performance in part represents the rebound from an appalling 2018, when the index dropped by 18.6 per cent amid trade war worries. Taiwan’s market, which is home to favourites such as Taiwan Semiconductor but fell by around 3.3 per cent in 2018, has made its own recovery amid broader equity gains around the world. In Brazil, the economy has been gaining some momentum in the wake of a recession, while policymakers have enacted reforms aimed at improving the country’s financial standing.

On the other side of the coin two popular markets with a decent level of representation in the index have put in a tepid performance this year. Korean equities have only made a very modest return, while equity gains in India – once a very strong performer – have slowed alongside the economy.

 

A year in funds

Plenty of funds have prospered this year: as Table 2 shows, some had made returns of more than 20 per cent by the start of December. But, as with the US equity market, the fortunes of many popular funds are tied closely to a small group of companies.

Table 2: Fund performance to 1 December 2019 (%)
FundYear to dateOne yearThree yearsFive years10 years
JPM Emerging Markets23.8819.4845.0763.11110.46
Genesis Emerging Market trust share price22.7721.8137.9644.35106.68
Threadneedle Global Emerging Market Equity21.3616.8826.3433.0975.46
Lazard Global Active Developing Markets Equity20.3214.96   
Baillie Gifford Emerging Markets Leading Companies19.915.6248.169.81112.92
JPMorgan Emerging Markets Investment Trust share price19.8821.5956.8274.18148.46
Fidelity Emerging Markets19.1716.2932.8250 
Pictet Emerging Markets High Dividend18.9915.0328.9940.64 
Franklin Templeton Emerging Markets Investment Trust share price18.6915.1446.3348.2790.06
AXA Framlington Emerging Markets17.6115.6129.7546.3885.43
Source: FE. Primary share classes used for open-ended funds

Tech names Alibaba, Taiwan Semiconductor, Tencent and Samsung Electronics were the four biggest constituents of MSCI Emerging Markets at the end of November, making up 17.8 per of the index. These names can all be vulnerable to trade tensions between the US and China, but have performed well in the longer term, as well as making gains in 2019.

A look at the three funds with the best returns illustrates this: JPM Emerging Markets (GB00B1YX4S73) had 17.5 per cent of assets in these four stocks alone at the end of October, while they accounted for 12.5 per cent of assets in the Genesis Emerging Markets (GSS) investment trust and 23.6 per cent of the Threadneedle Global Emerging Markets Equity (GB00B10SJD63).

Other popular emerging market stocks are notable by their presence. Ping An Insurance, the biggest insurer in China and another of the largest positions in MSCI Emerging Markets, makes an appearance in the top 10 of both the JPMorgan and Threadneedle fund, as does Indian bank HDFC. Russia’s Sberbank can be found in the JPMorgan and Genesis top 10.

In terms of country allocation, the JPMorgan fund had a slightly bigger weighting to China than the index at the end of October, with a double-digit overweight to India. Sector-wise, the fund’s big calls are in financials, consumer discretionary and consumer staples. The Genesis trust lists China and India as its biggest regional allocations, but has greater diversification across countries.

The JPMorgan fund has a decent record of outperformance over time, for example. Other names in the table, such as Fidelity Emerging Markets (GB00B9SMK778), have held up well in the longer term too. When it comes to those who have had a more difficult year, even some renowned investors have struggled.

It may be early days for the Mobius Investment Trust (MMIT), but the fund has struggled since its launch in October 2018. The trust’s shares fell by some 12 per cent in the first 11 months of this year. The fund, which focuses on a “customised engagement strategy” with the small- and mid-sized companies it invests in, was also down in terms of underlying performance, if to a lesser extent. Another big name emerging market trust, Fundsmith Emerging Equities Trust (FEET), has also had a tough 2019.