InvestmentsMar 18 2016

Insight: Global Emerging Markets

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Insight: Global Emerging Markets

The Global Emerging Markets (GEM) sector is in a state of constant volatility. Performance depends on a range of factors that include economic and political conditions in these countries, market dynamics and external factors such as a change in the US Federal Reserve monetary policy or volatility in oil prices.

In the past year, emerging markets have been impacted by a number of events. And while each of these countries has different domestic situations, they are clubbed under a single sector for UK investors.

The GEM sector sits under the Investment Association’s (IA) overseas equities unit and includes funds that invest 80 per cent or more of their assets in equities from emerging market countries as defined by the relevant FTSE or MSCI emerging markets and frontier indices. The maximum frontier equity exposure is restricted to 20 per cent of the total fund.

A chart on performance of indices in 2016 from Financial Express shows that, although emerging markets have had a tough journey so far, they have outperformed developed markets. The year started with a crash in the Chinese equity markets. Stocks fell by 7 per cent following the release of weaker than expected manufacturing data.

Concerns over a Chinese slowdown continue to worry investors exposed to this sector. But analysts have suggested that, while the volatility in Chinese market is concerning, the country will not collapse. The Chinese government is currently trying to move its focus from manufacturing to service. Many fund managers claim that developed markets have over-reacted to concerns surrounding China, but that markets will recover this year.

However, the impact of market turmoil can be seen on funds in the GEM sector.

The average return for the GEM sector over a one-year period is just £867 on an initial investment of £1,000 for unit trusts and £857 for investment trusts. 

Table 1 shows the best performing unit trusts and investment trusts in the sector over five years, according to data from FE. The best performing open-ended fund is the PFS Somerset Emerging Markets Dividend Growth fund, which has returned £1,221 over five-years. It has underperformed over one year with a return of £894. The fund holds 16.0 per cent in banks, its highest allocation. In terms of regions, the fund’s largest allocation is to South Korea, with 20.1 per cent allocated to the country’s equities. The country breakdown list also includes Hungary, India, the Philippines, South Africa Taiwan and Turkey and among others. 

The second best performing fund in the space is the Templeton Emerging Markets Smaller Companies fund. While the fund has underperformed over a one-year period, it shows a return of £1,201 over five years. It has a heavy weighting to consumer discretionary, followed by information technology and consumer staples. Its regional dominance can be seen in India and South Korea and other emerging nations. 

When it comes to investment trusts, the top performer is Utilico Emerging Markets trust, which returned £1,311 over a five-year period, 5.6 per cent annualised. Launched in July 2005, the £419m fund has a high exposure to gas, followed by electricity, ports and airports. Its highest country allocation is 25.6 per cent in China, followed by 15.3 per cent to Malaysia and 9.4 per cent to Brazil.

The second best performing fund is the BlackRock Frontiers investment trust, returning £1,239 over the same period. The £197.2m fund invests across a range of sectors. The fund has its highest allocation of 34.8 per cent in finance, followed by 20.1 per cent in consumer staples. The fund has exposure to emerging economies such as Argentina, Bangladesh, Kazakhstan, Pakistan and Romania.

It is worth noting that most of the funds have exposure to financials, consumer discretionary and healthcare. Most funds choose to stay away from sectors such as commodities due to the volatility in current markets. The regional focus for funds in this sector remains diversified. Emerging economies such as Russia are not popular, but there is an increased exposure to countries such as India, Indonesia and China.

While it is true that the Global Emerging Markets sector is risky, it is also quite evident that it could present an attractive option from a longer-term perspective. In this risky and volatile market, long-term investment is probably the new way to earn higher yields.

GEM: FIVE QUESTIONS TO ASK

1. How many funds are available under the IA GEM sector?

A total of 94 funds sit within this space. These include 84 unit trusts and 10 investment trusts. Table 1 (overleaf) lists the top 10 funds in each space.

2. What are the charges for these funds?

These funds have ongoing charges that typically range between 1.5 and 1.75 per cent. While every fund has a different ongoing charge that also includes performance fees, it remains within the broad range mentioned.

3. Are these funds available to UK investors?

Yes, all funds listed in the GEM sector are available to UK investors, either through a platform or an independent financial adviser.

4. What are the advantages of investing in GEM sector?

The sector is attractive for those looking for higher yields in the longer run. Data shows that emerging markets outperformed developed markets in 2016 and risk-tolerant investors can view this as an option.

5. What are the risks to consider?

One of the biggest risks with emerging market investments is currency risk. Currency fluctuation between the share class currency and the base currency of the fund can impact the value of an investment in the fund. In order to hedge against this risk, investment companies apply a number of strategies, such as the use of derivatives.