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First-rate First State

Emerging markets may be volatile but the First State team are finding opportunities

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I don’t know about you but I am getting tired of big headlines warning us of a crash waiting to happen in emerging markets. I don’t wish to tempt fate but are we really going to see an Asian financial crisis, a Russian debt crisis or even a repeat of the tequila crisis in the next 12 months? This time, the embedded problems are in the developed markets like the UK and Europe and it is these economies to be wary of.

There is no question that after an exceptional run in the last year, emerging markets could weaken this year. There are already signs of this happening. In the year to February 15, the MSCI Emerging Markets index is down by 3.5 per cent in sterling terms (Source: Lipper) and these markets are likely to be volatile this year as global uncertainty prevails. As with all things, however, this needs to be put into context.

It is perhaps worth going back to basics to understand emerging markets. Emerging markets are countries that are going through a period of rapid growth and industrialisation. Most important, emerging markets stand out because they have certain characteristics. Many of these countries have large populations and resource bases and are undergoing economic or political reform. Their economic success will spur development in the countries around them. They can vary in size from the very big like China to the smaller economies like Thailand. However, one thing they have in common is that they are likely to be among the world’s fastest-growing economies.

One emerging country that concerns many commentators is China. The economy has swelled in recent years and it is on track to become the second-biggest economy in the world. Since the Chinese authorities have indicated they need to cool growth, its stockmarket has been heading south but this will create opportunities.

Brazil is another area of concern, particularly over the last year as the market has performed extremely well and there are questions over the attractiveness of their valuations.

Emerging markets are not just made up of the Brics (Brazil, Russia, India and China). There are 24 emerging markets and tens of thousands of companies in these markets. There may be periods when some economies are not attractive as others but at an individual company level there is a wealth of opportunities.

This is precisely what Jonathan Asante aims to take advantage of when managing the First State Global emerging markets leaders fund. He has a particular focus on quality, which means he invests in companies with real earnings and profits. He does not follow the herd into stocks that are driven by momentum and he maintains a defensive bias.

Some parts of India, Brazil and China look expensive but there are pockets of value at the company level. For example, Mr Asante has been buying into Bharti Telecommunications, an Indian company that many investors have been selling due to fears over competition. Going against the herd, he has bought shares in the company at lower prices as he believes competition will prove beneficial in the long run because it will promote innovation. He is also finding attractive opportunities in less mainstream areas, including South Africa, Israel, Korea and Taiwan.
As it is likely to be a volatile year for emerging markets, the fund is cautiously positioned.

It has retained its exposure to gold mining companies, which are expected to show resilience amid a turbulent backdrop. There is significant exposure to consumer areas that are expected to benefit from demographic trends and a growing middle class population, whose higher aspirations will lead them to buy luxury goods such as mobile phones, cars, and houses.

During periods when markets are falling, this fund tends to outperform. Conversely, given its defensive nature, it is likely to fall behind its sector during a strong rally. Importantly, the First State emerging markets team has more than made up for any underperformance when markets falter, which is why they have an outstanding long-term track record. It may be a bumpy ride this year but some experts compare the current period to the 1970s when developed markets struggled to perform and emerging markets raced ahead. The long-term story is intact and I believe the First State fund is a superior way to gain access to emerging markets.

Meera Patel is senior analyst at Hargreaves Lansdown

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