Investors would be wrong to turn their back on active funds in favour of passives
For the second year in a row, investors have been rewarded for allocating to emerging markets, with 2017 returns for the MSCI EM NR index at 25.4 per cent versus 13.2 per cent for the global MSCI ACWI index.
Country level contribution data shows the hugely significant impact from China, which has been responsible for approximately 40 per cent of that gain. So, what has driven these strong returns?
Essentially, a combination of the market’s realisation that Chinese economic growth has stabilised, the continual top-line growth in technology and consumer sectors, and early results from the state-owned enterprise/supply-side reforms have all played a part in a broad-based earnings recovery not seen in several years.
If we dig a little deeper into the emerging markets data, we can see further concentration in terms of individual stocks, with the top five contributors accounting for around 9.4 per cent of the gain.
Tencent, Alibaba, Samsung, Naspers and Taiwan Semiconductor (all of which are IT/internet related) now form the top holdings within the index and, more interestingly, four were the top index constituents at the start of 2017.
Given this concentration of returns in the top names, it is unsurprising the average active equity fund underperformed the index over the year.
Emerging markets saw significant positive flows in 2017, following almost flat flows in 2016 and outflows the previous year.
In terms of the largest individual fund beneficiaries, there are the expected passive products within the top 10. But investors have clearly not turned their backs on active management in this space, with seven of the 10 being actively managed.
This highlights a belief that, over time, emerging markets will offer a range of opportunities that talented managers should be able to exploit. That said, dispersion between the returns of the best- and worst- performing funds is significant within this sector, underscoring the importance of robust fund selection.
Here we highlight some of the global emerging market equity funds rated positively by our fund analysts.
Comgest Growth Emerging Markets is run by experienced manager Wojciech Stanislawski alongside Emil Wolter and Charles Biderman. Stanislawski has been part of the management team on this strategy since 1999 and is supported by a well-resourced team of analysts. The investment approach is focused on sustainable growth stocks and the bottom-up portfolio is reasonably concentrated. Most cyclical stocks are excluded from the investment universe and the names that make it into the fund tend to be held for the long term. It is Gold rated by Morningstar.
JPM Emerging Markets Equity holds a Morningstar rating of Bronze. There was a lead manager change in 2016, with Leon Eidelman officially taking control from Austin Forey. Eidelman has considerable experience at the group, having joined in 2002. He continues to use the established bottom-up process that has a quality growth bias but may look to take advantage of short-term macro weakness to provide attractive entry points. The manager draws heavily on the considerable resources at the group, particularly the GEM and China analyst teams that total over 25 individuals. The portfolio is reasonably diversified and is one of the few to have perf-ormed well in both 2016 and 2017.
Aberdeen Global Emerging Markets Equity is managed by a well-resourced and experienced team led by Devan Kaloo. Stock research focuses on companies with strong balance sheets and sustainable business models, producing high returns on assets. A longer-term approach is adopted, and deviations from benchmark allocations can be significant. The fund had a difficult 2017 but has proved its worth over the longer term. Morningstar rates it Silver.
Fidelity Emerging Markets is built from the bottom-up. Manager Nick Price has been at the helm since 2009. A team of over 40 analysts located across the globe feed research into regional portfolio managers, who then provide Price with three portfolios that are the primary universe for this fund. Price will take this input but also conducts a lot of his own due diligence on individual companies. The portfolio shows clear growth characteristics as well as quality aspects in terms of lower debt and higher margins than the index. The fund holds a Morningstar rating of Bronze.
Simon Dorricott is associate director, equity strategies, manager research at Morningstar