The recent revival of the FTSE 100 index means that the UK is no longer in the doghouse of world markets. That position is now occupied by emerging markets, with a 7% loss over three years for the MSCI Emerging Markets index in sterling compared with a gain of 24% for the UK’s All-Share index.
Nevertheless, as Andrew Ness, the manager of the Templeton Emerging Markets Investment Trust (LSE: TEM) points out, emerging markets “generate 65% of global GDP growth [and] offer a range of world-class companies and exciting investment opportunities”. Earnings growth “is forecast to be 18% – double the growth expected globally”, yet emerging markets trade on just 12 times forward earnings.
Asian emerging market investment trusts
Asia comprises more than 80% of the index. China, India, Taiwan and Korea jointly comprise nearly 75% of it. Yet investors worry about the risk of Chinese aggression towards Taiwan, their investments in Russia having been wiped out when Russia invaded Ukraine. They have become disillusioned with China, due to the collapse of the property bubble, which has hampered growth. In addition, political crackdowns, poor corporate governance and increasing authoritarianism do not inspire confidence.
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The performance of India has been phenomenal, yet it now trades on a multiple of 24 times historic earnings. However, the Chinese market has bounced by 20% in the last three months as confidence has recovered. The Indian economy is growing by 6%-7% per annum, powering annualised earnings growth of over 20%. This year’s strongest market has been Argentina, with a gain of 43% in US dollar terms, suggesting opportunities outside the big four countries.
The success of Mercado Libre, the Latin American e-commerce company that has grown from start-up to a market value of $89 billion in 25 years, shows that the entrepreneurial spirit thrives outside Asia as well. The broader opportunity and the ability to switch focus between regions, countries and sectors makes emerging market trusts more attractive than Asian or country specialists. The sector leaders, TEM, with a market value of £1.7 billion, and the JPMorgan Emerging Markets Investment Trust (LSE: JMG) with £1.2 billion, have struggled over three years. Both have slid by 11% in that time frame, but have recovered strongly in the last year. TEM, on a discount to net asset value (NAV) of 15%, has returned 13% (compared with a 10% gain by the benchmark index), while JMG has returned 3% but trades on a discount of only 12%, perhaps owing to its strong long-term record.
The top performer over one year, however, is the £530 million Fidelity Emerging Markets Limited trust (LSE: FEML), which has returned 17% and trades on a 11% discount. FEML was once the Genesis Emerging Markets Fund and had a market value above £1 billion, but in 2021, after a period of mediocre performance, the directors panicked and switched management to Fidelity, despite Genesis’ strong long-term record.
Higher risk – and higher potential rewards
There followed a wretched couple of years, marked by a sizeable but disastrous bet on the ostensibly cheap Russian market. But since then, Fidelity has turned itself around. Managers Nick Price and Chris Tennant have the ability to invest in small and mid-cap firms as well as large companies, and may also sell short. This means performance can benefit from both winners and losers.
These short positions increase the risk, but also the potential reward, as does moderate gearing, achieved through derivatives rather than borrowings. The fund is also partly hedged by selling short index futures contracts, so that although the gross portfolio is worth 160% of NAV, net equity exposure is only 109%. While the focus of the managers is on picking stocks, political and economic factors cannot be ignored.
As a result, the portfolio is very light on exposure to China but compensates with high exposure to Hong Kong. Brazil, Mexico and South Africa merit an allocation of at least twice the MSCI index, but Taiwan and South Korea are severely under-represented. By sector, financials and consumer-discretionary companies are favoured at the expense of healthcare, energy and technology. Although Taiwan Semiconductor accounts for 10% of the fund (2% more than in the index), only one other holding is above 5% and the portfolio is reasonably well diversified.
Based on Fidelity’s own analysis, the portfolio is growing faster than the benchmark index, boasts better cash generation and a higher return on assets, but is cheaper. Inevitably, the managers are optimistic: “The asset class is trading at a deep discount to developed markets and we believe the outlook for emerging market equities is improving, their central banks having been among the most proactive in the world when it came to raising rates early and bringing inflation under control.”
Diversify your portfolio with three investment trusts
Three other emerging market trusts deserve a look. The £150 million Mobius Investment Trust (LSE: MMIT), set up by Mark Mobius after he “retired” from Templeton, has the best performance record over five years in the sector at 48%, compared with just 14% for the index.
Just behind it is the £280 million BlackRock Frontiers Investment Trust (LSE: BRFI), although its three-year performance of 44% is the best in the sector. But it invests outside the markets that dominate the MSCI Emerging Markets index (China, India, Taiwan, Korea, Brazil, Mexico and South Africa), so it has negligible overlap with other trusts in the sector. The £430 million Utilico Emerging Markets has gained more than 30%, but is a specialist trust focusing on utilities. It, therefore, has a negligible overlap with the rest of the sector and the index. Its shares, however, yield a generous 3.8%.
Finally comes the recently launched Ashoka WhiteOak Emerging Market Trust (LSE: AWEM), with a market value of £35 million. It has had a flying start since it listed just under a year ago, and is managed alongside Ashoka’s highly successful New India Trust. AWEM has recently made an audacious approach to merge with the ailing Asia Dragon Trust, which has £700 million of assets. If successful, this would create a major new trust in a sector that is just beginning to find favour among investors again.
This article was first published in MoneyWeek’s magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.