Blending a top-down framework that identifies countries with supportive growth conditions with bottom-up analysis that finds quality companies on attractive valuations has helped the £219.1m Hermes Global Emerging Markets fund outperform its IMA peers across one, three and five years.
Manager Gary Greenberg notes: “The world economy is undergoing deep structural changes that make equity markets particularly complex. We believe the best way to add value is through an investment process that integrates top-down and bottom-up analysis.”
The manager says the blended style typically results in 75-85 per cent of excess return coming from stock selection, with country allocation making up the remainder.
“Running a concentrated portfolio, it is important to pay attention to the broader picture,” he adds. “Events like the Tequila and Asian crises prove that macro matters in emerging markets. Country selection decisions are supported by quantitative models and qualitative considerations. A proprietary quantitative country model’s output forms part of a quarterly country allocation meeting, which provides an opportunity to review macroeconomic trends and key drivers.”
For the five years to March 26 2014, the fund has delivered an impressive 90.25 per cent, compared with the IMA Global Emerging Markets sector average of 59.02 per cent. It has also outpaced the sector in one and three years, albeit with small losses, according to FE Analytics.
The portfolio is relatively concentrated – there are roughly 74 holdings – with the manager noting an overweight position to Asia and an underweight to Latin America and Central & Eastern Europe, Middle East & Africa (CEEMA).
He adds: “China remains the biggest overweight position, with an increasing exposure to China A-shares, as we expect reforms to re-rate these stocks. We have increased our weighting in India recently, as we expect conditions to stabilise, resulting in good earnings for banks and infrastructure players. In particular, we expect IT companies to flourish as the migration to the Cloud accelerates.”
The manager attributes stock selection in Asia as the main contributor to performance. Examples include Galaxy Entertainment, a Macau-based hotel and casino operator, which was the top contributor to the fund, and China Mengniu Dairy, China’s leading dairy company, which announced a joint venture with Danone that prompted a re-rating.
On the flip side, Polymetal, a Russian gold and silver miner, was the largest detractor in 2013, falling amid negative sentiment on precious metals and the stronger dollar.
Elsewhere the team has a zero weighting in Mexico. “[While] it looks increasingly attractive from a top-down perspective, you are paying two times the multiples as in China,” the manager says. “From a bottom-up perspective, it is hard to find value”.
In addition, he notes: “We reduced our overweight to Russia even before the crisis took place, as we had a pretty negative outlook for the Russian economy. We believe the invasion and sanctions will push the Russian economy into recession. We’ll see negative growth for a few quarters, but we expect the Russian situation to calm down and, over the next year, the economic outlook to improve, leading to a reversion to the mean for the Russian stockmarket.”
Looking ahead, the manager signals caution in the short term, “given negative sentiment and momentum, the [US Federal Reserve’s] effective tightening and upcoming elections in many emerging market countries”.
But there are some glimmers of hope, with the manager noting that although 2014 will not be a year of accelerating economic or profit growth, valuations are attractive.
He explains: “If reforms get moving in India and Indonesia, continue in China and Mexico and get started in Brazil, emerging markets can get back on track towards the latter part of the year. Current valuation levels normally signal more upside than downside for emerging markets, but this will be a transitional year, with a lot of moving parts.”
EXPERT VIEW
Darius McDermott, managing director, Chelsea Financial Services
VERDICT
“The manager uses a very disciplined, contrarian style of investing with this fund, targeting quality companies trading at attractive valuations in countries that are supportive of growth. This style tends to work well in emerging markets, and the fund’s performance reflects this. The fund tends to outperform in falling markets, as it did last year, and underperform slightly in rising markets. It has a high weighting to Asia (roughly two-thirds of the fund). The manager has been using depressed valuations in China and Korea to pick up some quality companies with a margin of safety.”
