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Bottoms up

Scott Spencer

For the last two years, the market has been pursuing a macro asset-allocation strategy with a risk-on/risk-off mentality. The credit crunch and the European sovereign debt crisis encouraged investors to be more macro-driven. As money poured out of developed market equities and into emerging market and commodities funds, many investors made a decent return. But just how decent a return they got depends on which manager they picked.

Being overweight emerging markets in 2010 was a good call. The MSCI global emerging markets index rose 16 per cent. But the top fund in the IMA’s emerging market sector returned 38.5 per cent compared to only 11.4 per cent for the worst-performing sector, which shows that generating excess returns in emerging markets requires experience, patience and the right investment process, rather than simply taking a top-down approach. Only around 20 per cent of Gem funds outperform their benchmark over three and five years.

One might actually have been better off investing in developed markets, which are inherently less risky. Even in an environment in which investors were embracing risk, with equities outperforming bonds, a sterling corporate bond fund such as Old Mutual’s returned 15.8 per cent, beating a lot of emerging market funds.

Getting the fund selection right is not just something you need to do for markets that have benefitted from the recent macro investment drive. Equally large differences in returns within individual fund sectors can be seen in Japanese equity funds, global bond funds and absolute return funds.

Recent shifts in market sentiment indicate we might be starting to exit the risk-on/risk-off world, as financial markets focus on idiosyncratic stories instead of systemic themes. Because of inflation concerns and rising interest rates in Asia, global asset allocation is switching from an emerging market overweight to a developed market focus.

If this makes markets more bottom-up then selecting skilled managers will be even more important.

Scott Spencer is a senior portfolio manager at Aberdeen Asset Management

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