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EM goes contrarian
What to do about emerging markets? It's a more pressing question for DFMs now the asset class has returned to favour this year. The MSCI EM index is now back ahead of global benchmarks over the past six months, which has given three-year figures a boost, too.
This is a region where DFM fund selections have struggled in the past. But when short-term performance is good, the narrative in favour of EM exposure becomes difficult to counter – because arguments about long-term outperformance, robust demographics and the like have long been ingrained in investors' thinking.
So for those tempted to think otherwise, the latest Equity Gilt Study from Barclays makes for interesting reading:
We challenge the conventional wisdom that emerging markets are where returns are to be found over the long term. EM’s advantages of population growth and expected productivity convergence might be significantly exaggerated.
A more realistic assessment that accounts for actual demography and the effects of recent technological progress implies that the trend underperformance of EM assets and currencies that began in 2013 might have a significant amount of room to run.
Barclays adds that even sharp outperformance from EM economies has often not been reflected in asset prices. What’s perhaps more notable is the authors of the report are not alone in their stance: as we reported earlier this year, Credit Suisse’s latest Investment Returns Yearbook has questioned the theory of EM’s long-term outperformance, too.
What does that suggest for portfolios? If the EM narrative starts to falter in the short-term, those DFMs with misgivings may have more than one reason to feel vindicated. The counter-argument is the travails of recent years have already given discretionaries the right view of emerging markets: a contrarian play for the hardiest backers
Not so different
A couple of weeks ago we discussed how discretionaries’ active UK equity allocations collectively centre on just four funds: Lindsell Train UK Equity, Liontrust Special Situations, Investec UK Alpha and Man GLG Undervalued Assets.
While these funds do form the building blocks for many model portfolios, they’re often accompanied by satellite selections rather than one another. That said, 25 per cent of those wealth managers in our database do use more than one of the above in the same strategy.
Add in the next tier of UK equity favourites - funds like Majedie UK Equity, JOHCM UK Dynamic, Franklin UK Managers’ Focus and Polar Capital UK Value Opps - and you start to account for a sizeable chunk of DFMs’ UK equity exposure. So working out how well these portfolios complement each other is an important task.
The surface-level data needs little introduction. Of the funds mentioned, half - Man GLG, Majedie, Polar and JOHCM - have something resembling a value bias. The remainder are growth-oriented.
Yet of the former group, only Man GLG’s portfolio had a P/E ratio lower than that of the FTSE All-Share at the turn of the year, according to Morningstar Direct. Price-to-book metrics are a little more reassuring for the value cohort, but this is one sign that things aren’t always straightforward for fund selectors.
When it comes to correlations, things are even thornier. All UK equity funds are naturally going to be pretty highly correlated with one and other and their index - only Lindsell Train has a correlation of less than 0.9 with the All-Share, per Morningstar.
But there are some surprises in the data: despite its small-cap skew, Liontrust Special Sits has a pretty strong relationship with the other UK equity favourites. Less surprisingly, Lindsell Train’s concentrated portfolio makes it stand out a little. Its relationship with Majedie UK Equity - a correlation of 0.73 - is the only pairing to score below 0.8.
Research from platform Willis Owen suggests that star managers do worse than average once they change jobs. The one large caveat is that this finding was derived from just eight data points: big-name managers who joined new firms between 2013 and 2016.
That same small dataset indicates that DFMs are happy to follow a manager to a new home: new funds like Artemis US Extended Alpha or Investec UK Alpha are some of the most popular in their respective sectors. But all eight managers’ former funds have been completely abandoned, save for a single holder of Threadneedle UK.
On this latter aspect, the data is slightly more supportive: a previous study by Willis Owen, this time encompassing a slightly larger group (15 funds), found outperformance levels dropped significantly when high-profile managers left. That may relate to managing outflows as much as anything else, but if so that merely underlines there’s more room for improvement when it comes to succession planning.