The EM funds that thrived

Emerging markets funds appear to have a lacklustre track record in making the most of upswings in the market, the latest research by Money Management shows, although a handful are performing much better.

Over the past 10 years, the average fund in the AMI Equity Emerging Markets sector has an upside capture on the MSCI Emerging Markets index of 77.87 per cent, according to FE Analytics data.

The upside capture ratio shows the performance of a fund in an up market relative to the benchmark. This ratio should be greater than 100 per cent, as this would mean that during periods when the market is up, the fund did even better on average.

However, the 10-year upside capture of the average AMI Equity Emerging Markets fund suggests that less than 80 per cent of the market’s up periods have been captured.

That said, emerging markets funds tend to be stronger than the market in more challenging conditions. FE Analytics shows the downside capture (which measures relative performance in down markets) of 97.54 per cent.

But this is not enough to offset the weak upside capture numbers and goes some way to explaining which the AMI Equity Emerging Markets sector has lagged the MSCI Emerging Markets index by such a wide margin over the past decade – as illustrated in the below chart.

Performance of AMI Equity Emerging Markets vs MSCI Emerging Markets over 10 years

Emerging_market_bull_funds_1

Source: FE Analytics

But many investment analysts are now pointing to emerging market equities as an area that looks well placed to outpace developed markets, following a period of significant underperformance.

A recent note by strategists at Switzerland’s Pictet Asset Management argued that investors should “retrench from developed world stocks” and consider allocating more capital to emerging market equities to make the highest returns over the coming years.

“One bright spot in the equity market will be the emerging world. Emerging market stocks have the potential to deliver double-digit annual returns over the next five years as these economies will benefit from a weaker US dollar. When the dollar depreciates, emerging market stocks perform especially well,” the paper said.

“The end of the bull market for the dollar is likely to be a boon for emerging stocks for two key reasons: it will reduce capital outflows from emerging economies and will also result in lower inflation. Investors in emerging market stocks could also benefit from economic restructuring programmes. A number of emerging countries, such as India, Brazil, Indonesia and Saudi Arabia, are implementing structural reforms that should boost their growth potential and enable their governments to reduce external debt.”

“That’s not to say emerging markets are less risky than they have historically been. Should global trade succumb to protectionist measures from the US administration, and were China to fail to contain the rise of private debt – neither of which forms part of our base-case scenario – the developing world would be in vulnerable position. To insure against such risks, we would advocate allocating capital to countries with a large domestic economy, that have low levels of public debt and that are home to a relatively young population – such as India and Indonesia.”

However, given that the average AMI Equity Emerging Markets fund seems to have weak record in capturing the market’s upturns, where should investors look.

We looked the upside capture ratios of all the members of the sector to find out if any had managed to achieve a score of more than 100 per cent - but it must be kept in mind that past performance is not a guide to future returns.

Only 13 funds have a 10-year track record and none have an upside capture ratio higher than 100 per cent. The best performer is a passive vehicle – Vanguard Emerging Markets Share Index – and its 10-year upside capture stands at 98.97 per cent.

Looking over five years – which have been a difficult time for emerging markets – widens the field somewhat. The average fund in the sector has an upside capture of 90.20 per cent, so is still tending to miss all the market’s upside.

But 11 funds do have an upside capture greater than 100 per cent and they are revealed in the table below.

Emerging_market_bull_funds_2

Source: FE Analytics, data to the end of June 2016

It must be noted that all of these funds are benchmarked against the MSCI Emerging Markets index, especially the top-placed offering which ignores large swathes of the index as it invests in companies listed in Brazil, Russia, India and China.

After narrowing down the selection one more time to only look at those funds with an upside capture of more than 100 per cent and return that is higher than the 62.25 per cent made by the index, we are left with five names: Russell Emerging Markets, BlackRock Global Enhanced Emerging Market, CFS First Choice Wholesale Emerging Markets, Schroder Global Emerging Markets, and CFS First Choice Emerging Markets.

Russell Emerging Markets has made the highest return of the five after gaining 73.69 per cent over the five years to the end of June 2017. FE Analytics shows that the $201.3 million fund sits in the top quartile of the AMI Equity Emerging Markets peer group over one, three and five years.

It’s structured as a multi-manager fund, overseen by Russell’s Kathrine Husvaeg. Alliance Bernstein runs the largest chunk of the portfolio, with 17 per cent being manager with a value style; Numeric runs 16 per cent with a value/momentum approach and Oaktree Capital looks after 15 per cent with a market-orientated approach. Other managers working on the fund include Genesis, Harding Loevner, RWC Partners, Somerset Capital and Westwood International Advisors.

Commenting on the fund’s outlook, Husvaeg said: “We remain cautiously optimistic on emerging markets in the medium to long term; a view based on improving fundamentals in the region and attractive valuations relative to their developed counterparts. Further, we expect a continuation of positive data to drive a cyclical recovery in the sector”.

“For now, we remain underweight Asia – particularly select markets such as Malaysia, Taiwan and South Korea, where we have negative outlooks – and overweight Turkey and Russia; countries where we believe valuations are attractive,” she said.

Gary Jackson is editor of FE Trustnet, Financial Express’ London-based fund research website.