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A trend, not an enemy

Emerging markets may not provide safe havens but they are winning over growing numbers of longer-term investors, reports Gregor Watt

With all the problems in the eurozone, many investors are looking to emerging markets for some respite from the rollercoaster ride of UK and European equities.

Recent IMA statistics have flagged up the continued appeal of the sector. It was the fifth most popular for retail investors in April, with £136m in new inflows, marginally behind UK equities.

IMA director of markets Jane Lowe says April was a bumper month for retail sales in general, with £2bn of new money. “All the main asset classes saw healthy inflows.

Fixed-income funds remained the top-selling asset for the eighth consecutive month but all the mixed-asset sectors saw positive inflows. There was a mixed picture in equities, with inflows to global, Far East and UK sectors outweighing outflows from sectors with European equity exposure.”

According to a recent survey by Franklin Templeton, 43 per cent of retail investors expect the best returns over the next five years to be from emerging markets, while 35 per cent back developed markets.

Franklin Templeton UK country head Ian Wilkins says: “UK investors, given the global economic uncertainty, have a home bias in the near term. However, taking a longer view, investors are increasingly bullish on frontier and emerging markets, hence the more willingness there is by investors to increase global asset allocation over the long term.”

The ability of emerging market equity funds to provide some insulation from the volatility of more developed markets has been mixed.

On average, the sector has returned -12.9 per cent in the 12 months to May 31 but 29.4 per cent and 22 per cent over three and five years to this date. This compares to -8 per cent, 34.4 per cent and -7 per cent for UK all companies and 3.3 per cent, 50 per cent and 15.1 per cent for US equity funds over one, three and five years.

However, the potential to provide some escape from the travails of the developed world depends on emerging market economies being sufficiently economically independent. The past five years has proved that the theory of decoupling, which suggests emerging markets perform separately to developed markets, does not hold water.

Selftrade economics and markets adviser Stephen Barber says: “When the credit crunch brought markets to their knees four years ago, an investment myth was exploded. That myth was decoupling, the concept that the economies of China and the US were no longer correlated. The financial crisis put paid to that as economies of the East and West declined together.”

The past few years have seen many asset classes experience a short period of strong investment performance, only to be followed by a very poor one.

Barings’ data shows the volatility many sectors have experienced in the past five years, with emerging market equities particularly badly affected.

In 2007, emerging markets was the best-performing asset class, returning 37.4 per cent, but it was the worst performer of 2008, ending the year down by 35.2 per cent. This was followed by two consecutive good years, returning 59.4 per cent in 2009, when it was again the best asset class, and 22.9 per cent in 2010. But by 2011, it was again the worst performer, losing 17.6 per cent.

Baring multi-asset fund manager Andrew Cole says: “The data highlights how the performance of commonly used asset classes can reverse over a short period of time.”

Chelsea Financial Services managing director Darius McDermott says emerging market funds still lag behind the top-selling sectors. “We are seeing a trend for more people investing in emerging markets but it still has a way to go to overtake UK income and all companies.

“Emerging markets tend to be higher beta. They often outperform in good conditions and underperform in poor ones.

“In 2008, global markets were bad but emerging markets were dreadful and then in 2009, they bounced hard. We think emerging markets are underinvested, given the long-term growth story, but they have not suddenly become low risk.”

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