Interest in emerging markets has surged in recent years, not least due to their stronger economic growth and promising outlook compared to the developed world. That said, emerging markets have faced their share of volatility this year. By way of example, let’s take a look at emerging Asia. Most emerging Asia markets posted solid gains over the first three and a half months of 2010, as investors remained sanguine about the region’s economies and prospects overall. But many of the exchanges suffered double-digit losses between mid-April and early June due to rekindled worries about the impact that weak global growth might have on the region, rising fears about inflation in China and India, and other concerns. Since then, however, many emerging-Asia funds have enjoyed strong gains thanks to renewed optimism about the economic situation in China, a surge of foreign investment in India, and further positive developments.
Looking further afield, the MSCI Emerging Markets Index has gained almost 13% year–to-date. Interestingly, some of the smaller markets have tended to perform better than their larger counterparts. For example, Thailand and Indonesia have gained more than 50% and 40%, respectively, whereas Korea’s KOSPI has seen gains of ‘only’ 20% year-to-date. This trend has also been reflected in some fund categories, with, for example, the Indonesia equity funds available for sale in the UK averaging 50% returns year-to-date while those in the Brazil, Korea and India equity categories have ranged from minimal returns to a maximum of 25% so far in 2010.
Against this backdrop, funds within the Morningstar Global Emerging Markets Equity category have gained on average 15% so far this year, with those that are heavy in small- to mid-cap companies posting the highest returns year-to-date.
Looking beyond the year-to-date returns, there are a number of funds in Morningstar’s Global Emerging Markets Equity category that offer the potential for investors to realise long-term gains from the economic expansion in these economies, without being exposed to excessive volatility. In fact, GEM funds that have earned Morningstar’s Elite qualitative rating have been the ones offering a combination of relatively low risk, above-average long term returns, and experienced managers at the helm. Of course, on occasion, that has meant sacrificing short-term gains and underperforming their category peers in momentum-led markets.
The below funds are a sample of those in the Morningstar Global Emerging Markets Equity category that have earned Morningstar’s highest qualitative ratings: Elite and Superior. This is by no means an exhaustive list: find funds across our rating spectrum in our Fund Screener. You need to register at Morningstar.co.uk to read our analyst reports—registration is fast and free.
Elite: Comgest Growth Emerging Markets
This emerging-markets equities fund has been managed with a clear and consistent preference for highly profitable companies capable of increasing their profits regardless of the economic cycle. As a result, most cyclicals and financials are purposely excluded from the investment universe, resulting in a concentrated portfolio of about 40 securities that bears little resemblance to the indices at the sector or regional levels. This approach served Comgest remarkably well in the 2008 downturn, when the fund lost 9% less than the category average, although during the recovery in the spring of 2010 staying away from cyclicals resulted in the fund underperforming its category. Regardless, our favourable outlook for the fund remains unswayed as we believe the fund is positioned to maintain its track record of overperforming in the long run. Experienced co-managers Vincent Strauss and Wojciech Stanislawski get our confidence vote, and we especially like that the fund's total management costs are also less than the category median. Read the full fund analysis.
Elite: First State Global Emerging Markets
This fund's people and process are top-notch. The fund invests for the long term and picks stocks with quality management, a strong business franchise, attractive valuations, and sustainable drivers of earnings growth. The latter consideration leads managers to shun some equities with highly cyclical earnings such as industrials and the energy sector. While we hold this fund in high regard and have awarded it our highest qualitative rating, we find its fees hike earlier this year disheartening. In February 2010, First State raised the annual management charge in the UK by 25 basis points to 1.75% at the same time as soft-closing the fund to new investors. Although not excessive relative to the median, the higher cost bites into existing investors' future returns and this gains significance when compounded over the long term. Read the full fund analysis.
Superior: Schroder ISF Global Emerging Market Opportunities
What makes this fund different is the flexibility it has with its investible universe: In addition to emerging-markets equities, the fund also has the ability to invest up to 30% each in global bonds and cash. The flexibility gives the team a great deal of freedom to deal with turbulent market conditions. This was perfectly shown by the fund’s performance in 2008 when it was a top-decile performer. Freedom like this is only good if the management team has the necessary skill set to take advantage, and we have full confidence in experienced manager Allan Conway and co-manager Nicholas Field. Read the full fund analysis.
Read our recent interview with Schroder's Head of Global Emerging Markets Equities, Allan Conway.
Superior: JP Morgan Emerging Markets Equity
This fund has the potential to attract investors with a long-term mindset. Manager Austin Forey targets stocks that have earnings growth potential but also pay a dividend as he believes a company’s dividend policy paints a clear picture of how it views corporate governance and treats its shareholders. Have in mind, however, that the fund can experience periods of relative underperformance, particularly during sharply rallying markets. The fund’s unwieldy asset base limits Forey’s ability to invest in small caps and such exposure can also be a source of outsized returns in emerging markets. Read the full fund analysis.
Read our recent article on JP Morgan's emerging markets closed-end fund offerings.
Superior: Lazard Emerging Markets Equity
A seasoned manager with a sound process makes Lazard Emerging Markets a compelling choice. Manager James Donald pays close attention to valuations, which leads him to sidestep hot stocks with embedded price risk, which protects investors’ capital relatively well during the inevitable dips in emerging markets. The fund’s strategy also looks at how cash flows feed in balance sheets, but it is unfortunately not sensitive to fraud, which led the fund to being caught up in the Satyam debacle and shedding 160 basis points in the first quarter of 2009. Read the full fund analysis.
Morningstar fund analyst Bridget B. Hughes, CFA, contributed to this article.
