As is widely known many emerging countries boast favourable demographics or are experiencing rapid urbanisation. Their markets can provide access to a long-term growth story where well-managed companies with unique assets, such as good distribution networks, are able to meet the demands of surging demographics and economic expansion. Questionable corporate governance, poor transparency, corruption and weakly functioning institutions are some of the risks of investing in the region. There are also question marks over the shorter term, such as whether China can transition its economy from one driven by fixed asset investment to a more services oriented, domestic dependent economy. The volatility of the asset class necessitates a long-term view but with low growth rates in many countries elsewhere around the globe and having underperformed developed markets in recent years, for the long-term investors in this asset class, the region may hold some appeal.
Whether one takes an immediate or longer-term view of emerging markets, due to the divergence of returns (e.g. stemming from the range of companies and countries), the need to be selective when choosing where to invest remains paramount. Good stock-picking managers with proven track records are generally hard to come by, however, in our opinion, there are some exceptional standouts currently investing in this asset class.
One that immediately springs to mind is the First State Stewart's investment team, an autonomous unit within First State Investments, which is responsible for its own investment decisions and recruitment. The team conducts in-depth stock analysis seeking only the highest quality companies, led by veteran investor, Angus Tulloch, one of the most respected investors in the region. The performance success of their emerging markets funds (and other First State Stewart products) has meant that it has attracted a considerable level of assets and the group have taken steps to restrict flows into some strategies. The limited availability of leading strategies without capacity issues is one of the immediate challenges facing potential investors in this asset class. Qualitative research on the new potential players has become ever more crucial, and we have highlighted a number of lesser known players below.
The Lazard Emerging Markets Core Equity fund benefits from a well-resourced and stable team that has worked together and applied the same investment process for well over 10 years. The approach is fairly conservative in its nature and looks to emphasise the team's stock picking skills rather than taking sizeable sector and country bets; deviation from the benchmark is therefore reasonably limited at both of these levels. Stock research is extensive and considers a variety of factors thereby providing the manager, Stephen Russell, with a flexible framework in which to select stocks at the various stages of their life cycle. That said, valuation is an integral part of the process and Mr Russell maintains a disciplined approach to this important element. This fund's short term performance history should not be looked at in isolation as the team has a long and successful track record managing assets in this style. The fund offers investors a well diversified portfolio of stocks that aims to meet its performance objectives with less volatility than the market.
The Somerset Global Emerging Markets fund offers access to a seasoned investor, Edward Robertson, and a supporting team with a strong emerging markets heritage. The manager aims to deliver meaningful outperformance of the MSCI Emerging Markets index over a market cycle. The fund may lag in very strongly rising markets when riskier stocks are in demand but the manager's preference for quality companies with resilient revenue streams should help cushion losses when markets are falling. Firms with sustainable earnings, high levels of free cash flow generation, healthy balance sheets, and good corporate governance constitute a core element of the manager's portfolio. Long-term quality is paramount but value is equally important to the manager. Mr Robertson believes, for example, that at certain points in the cycle there are opportunities to invest in quality cyclical companies that are on extremely compelling valuations. These firms, which are only cheap because the current economic cycle is against them but which have the potential to improve their returns going forward, will in general compose no more than 15% of the portfolio. We see this flexibility as a good discipline to have in a region where markets can move rapidly in either direction and this, together with a safe pair of hands at the helm, is an attractive combination in any asset class.
Given the divergent aspects of many emerging economies, investors who are confident on a particular economy, can instead opt for a single country fund. The Goldman Sachs India Equity Portfolio seeks to deliver significant outperformance against the reference index over rolling five year periods. The manager, Prashant Khemka, has been managing this fund since its inception in 2008 as well as the Goldman Sachs Growth & Emerging Markets Broad Equity Portfolio since 2013, and both funds follow the same investment principles. The manager has a very stock specific driven approach and ultimately he believes that outsized returns are earned over time by investing in undervalued businesses with strong or improving fundamentals. If he is right, the business value will surface over time. Whilst he is aware of macroeconomic and market sentiment, he is seeking to populate the portfolio with stocks that have different drivers of returns; he is not looking to time the market.
A long-term investment horizon is necessary to weather the ups and downs in this asset class. Consistency in the application of the investment approach is also key as emerging market funds are vulnerable to changes in sentiment and can face a host of risks including currency, economic and geopolitics.