The US dollar continued to climb against the emerging market currencies, with many fund managers choosing to buy emerging market debt rather than stocks in the countries themselves.
India’s currency, for example, fell to a record low of 68.8 rupees to the dollar in August – following a drop of 4 per cent in one week – despite the Reserve Bank of India’s efforts to stop the slide. The bank later announced new measures to buy long-dated bonds to counter a rise in yields.
According to JPMorgan’s Emerging Market Bond index of dollar-denominated sovereign bonds issued by a selection of emerging market currencies, they collectively fell 6.1 per cent in the second quarter of 2013, the biggest drop since 1998.
Trend spotting
Having spotted a trend among fund managers buying emerging markets bonds, the Investment Management Association (IMA) announced in August it was to create a Global Emerging Markets Bond sector, effective as of 31 December 2013.
The trade body said all funds wanting to be included in the sector would have until 31 March 2014 to comply with its new requirements, although new funds would have to comply at point of at entry.
The new sector will require all funds to invest at least 80 per cent of their assets in emerging market bonds as defined by a recognised global emerging market bond index. The IMA said funds in the sector must also be diversified by geographical area.
Emerging markets have suffered over the past three years, having relied heavily on demographic trends. The MSCI Emerging Markets index underperformed compared to the S&P 500 and FTSE 100. However, the sector’s breadth – covering countries from Latin America to Africa to Asia – means there are always new investments waiting to discovered.
Despite the negativity and underperformance, funds in the IMA Global Emerging Markets sector have been selling well over the past 12 months, except for August 2013 when there were almost £1m of outflows. It was the best-selling sector in October and December 2012 and again in January 2013, with net retail sales of £309m, £252m and £223m respectively.
The IMA stipulates that funds wanting to be in the sector must invest 80 per cent or more of their assets in emerging market equities as defined by the relevant FTSE or MSCI index.
According to the latest figures from the IMA, net retail sales in the sector reached £27m this October. Although not its highest selling month, it continues the positive trend for the year.
Fund performance
Table 1 shows the top-performing funds and investment trusts from the respective Global Emerging Market sectors ranked over five years.
The top-performing unit trust is the US$2.8bn (£1.71bn) Aberdeen Global Emerging Markets Smaller Companies fund, which returned £3,181 over five years based on an initial £1,000 investment – an annualised return of 26 per cent. The Luxembourg-domiciled Sicav fund’s highest country weightings are in Brazil, China and South Africa.
The top-performing unit trusts are dominated by Aberdeen, which has a strong emerging markets presence, with three funds in the top 10.
Global emerging market small-cap funds have been performing well, with three funds in the top 10 specialising in this area. The second-best performer, the US$539.4m JPMorgan Emerging Markets Small Cap fund, managed by Amit Mehta, has a 6 per cent overweight position in industrials, its largest sector holding.
Compared with other funds in the sector, the fund is 14 per cent overweight in South Korea – one of the sector’s greatest success stories of the past few years. The fund returned £3,130 over five years based on an initial £1,000 investment, a 25.6 per cent annualised return.
Investment trusts, unusually, have not performed as well as unit trusts. It should be noted, however, that only nine investment trusts in the sector have been available for at least five years, compared with the more than 80-strong unit trust sector.
The best-performing investment trust is the Africa Opportunity Fund. The $49.5m trust differs to many of its peers in that it has a one-continent strategy. Its highest exposure is to Ghana, where 28 per cent of the fund is invested, followed by 18 per cent in Senegal and 16 per cent in Zambia. The trust is listed on Aim on the London Stock Exchange and is domiciled in the Cayman Islands. It is managed by its two founding principals, Francis Daniels and Robert Knapp.
Outlook for 2014
With many countries now in a recovery phase, many analysts predict 2014 will be a better year for emerging markets. That said, not all emerging markets will benefit, and some may suffer from any tapering in the US quantitative easing programme.
One positive is that many markets are not correlated. For example, if something were to happen in Nigeria, it would not affect Argentina as much as it would a neighbouring African nation. Analysts also predict China will make a comeback during the year.
So, 2014 could be the year of the global emerging market.
Five questions to ask:
1. Which countries does the fund invest in?
Many funds will invest in the larger economies, although some invest mainly in smaller southeast Asian countries or African countries. It is possible to invest in both, but some management teams prefer a smaller focus.
2. What market cap does the fund specialise in?
Small-cap emerging markets funds may be higher risk, even though they have been popular and performing well. Look at what the fund is investing in and in which countries small-cap could be less risky.
3. Does the fund invest in frontier markets?
Some funds will invest in much less developed countries – frontier markets. With that comes greater risk, although potentially higher prospects.
4. Which currency is the fund issued in?
It may not make much of a difference, but be sure the fund is domiciled either in sterling or US dollars. Some are in local currency, although these should only be used for more risk-inclined investors.
5. What is the fund’s strategy?
Investors should always look at the fund’s strategy before investing. Different funds are made for different risk levels, and global emerging markets can be a particularly risky investment.
