Investor's Notebook: Why emerging markets shouldn't be unloved
It’s quite bold for a fund manager to try to persuade would-be clients to buy his product because of a vote 10,000km away — especially when there is a highly tenuous connection between the two. But I admire the cheek of the Denker Capital team in linking the Brexit result to the need to buy its emerging markets fund. Granted, it had a good start, outperforming the MSCI emerging markets index by 12.2% over a year. Denker’s most experienced portfolio manager, Kokkie Kooyman, characterises investing in emerging markets (EMs) as a flight to safety, in comparison to the possibility of a break-up of the European Union, as well as the frustration of blue-collar workers with the political establishment, which is also playing out in the US with the success of Donald Trump.
Neal Smith, a member of the Denker team and fund manager of the SIM Global Emerging Markets Fund, says EMs are likely to remain more volatile but they are now more predictable than developed markets. Some, such as India and Indonesia, have particularly high growth dynamics driven by internal reform. He says emerging markets are unloved, cheap and under-owned, even though Denker cannot tell you what growth will be in emerging markets.
It is a fact, though, that they have underperformed developed markets solidly for the past six years. Over five years not a single large emerging market has given positive returns in dollars, varying from minus 8% in Mexico to minus 22% in SA to minus 43% in Turkey and minus 66% in Brazil. Devaluation played a big part in the decline; the Turkish lira, Brazilian real and the rand all fell by more than 50%. In spite of that, since 1970, emerging markets have provided an annual return of 11.1% compared with just 4.6% for developed markets.
Smith says there is no need to be a full-blown supporter of EMs; historically just a 20% allocation is enough to materially reduce the volatility of a global equity portfolio and increase returns. He says the emerging market universe is disparate and it is worth focusing on those that offer the most value and potential. SA is not one of them as the p:e ratio is above not only EM peers but developed markets too.
Smith finds a lot of value in Eastern Europe — including Russian banks Sberbank and TCS and supermarket chain Magnit — and Latin America, with an exposure to Brazilian bank Itau. Brazil has been a happy hunting ground for the fund as the stock market there is up more than 40% in dollars so far this year, on the back of the impeachment of the president.
Smith has a heavy exposure to financials, which are 36% of the fund, no great surprise given the high financial exposure of the SIM Global Best Ideas Fund which Kooyman manages. It also has 30% in consumer discretionary shares, with shares such as casino group Sands China and Chinese online retailer VIP Shop, and 19% in IT, with counters such as Samsung Electronics and Chinese Internet giants NetEase and Alibaba. Both of those are much more attractive buys than Tencent or its shareholder Naspers, according to Smith. The SIM Global Emerging Markets Fund has no exposure to energy, utilities, health care and industrials.
Most of the fund’s metrics are almost level with the benchmark, whether it’s dividend yield, p:e or price to book. The main difference is that the fund has a substantially higher return on equity of 19.4% compared with the benchmark’s 16.3%.
I hope that one day the emerging markets will form part of the universe of global equity funds so we do not have to shop around separately for a satellite emerging markets fund.