Beef up your emerging market exposure
Wealth management firms are recommending that clients increase their portfolio exposure to emerging markets, often to 15% or more compared with around 5% two years ago.
The thinking is that this better reflects the emerging markets' burgeoning share of the global economy and will avoid portfolios incurring a systematic bias to the developed world.
Emerging markets already account for 35% of global GDP (50% at purchasing power parity), while the UK represents no more than 10%.
The second strand to this argument is that investing in emerging markets today is like investing in the Industrial Revolution 200 years ago. While developed markets offer the prospect of 2% to 3% annual growth, emerging economies are on growth trends of around 7% to 8%, increasingly fuelled by domestic consumption.
"There are growth stories all over the emerging market countries," says Dr Mark Mobius, veteran manager of Templeton Emerging Markets Investment Trust.
"If we look at the macroeconomic picture, the major growth countries are China and India, but there is high growth in a number of smaller markets, and particularly in frontier markets.
"We prefer the commodity and consumer sectors. Demand for commodities is soaring and the cost of discovering and producing commodities is escalating.
In the consumer area, per capita incomes in emerging markets are rising fast. That, combined with the large populations in India and China, means the demand for consumer products and services is growing rapidly."
In contrast, more mature European markets with ageing populations have little capacity to grow their spending. "The movement of factories to eastern Europe means less in the way of job opportunities for people in developed nations," warns Nick Price, portfolio manager at Fidelity.
"With the exception of hearing aids, it's a battle to find any product in sustained growth. Meanwhile, the Asian consumer is enjoying increased consumption of almost everything from clothing to autos."
The commercial potential of these populations developing western tastes is huge. For example, the annual volume of beer sales in Nigeria is growing by 10%. And the level of credit extension in poorer societies is low - even items such as motorbikes are purchased in cash.
In Vietnam, for example, only 10% of consumers have a bank account. The urbanisation of highly skilled workers is creating a dynamic and innovative commercial environment.
"Economic growth is compelling not only in China and India, but in Indonesia, Turkey, Brazil and Russia, which are well positioned for several years owing to current account surpluses and huge foreign exchange reserves," says Wim-Hein Pals, manager of the Robeco Emerging Markets fund. China famously has $2 trillion (£1.25 trillion) in foreign exchange reserves.
The transformation in fiscal and monetary status is marked, and is starting to make the evils that have dogged Asian markets - currency crises and the flight of capital - recede. But emerging markets remain volatile, as demonstrated by China's Shanghai Composite index, which fell back by 21% in August after doubling since November.
Mobius stresses that investors should take a five-year investment view and be prepared for extreme volatility. "There are always corrections, even in a bull market, and they can be violent, big and hard to catch."
One fear is that stock valuations are unreasonably high in relation to earnings per share and that Chinese output growth will ease back, while in Korea and India, there is also a renewed focus on falling export levels.
"Emerging markets have already bounced higher than the rest of the world, but my view is that this idea of emerging markets decoupling from the West has not yet materialised.
Last year when developed markets fell, they all fell, and I do think another downturn in developed markets would pervade emerging economies,' says John Dickson, head of investment consultancy at Hymans Robertson.
"Valuations are now at long-term historic averages, but we still feel stocks offer excellent long-term growth and will see good sustainable profits," argues Emily Whiting, a lead portfolio manager on the JPMorgan Emerging Markets Investment Trust.
"A particular inefficiency is that banks have been grouped and sold down together, particularly Chinese financial names that we like but previously considered too expensive."
Access to these markets has become easier over the past decade. Exchange traded funds (ETFs) offer immediate exposure with prices quoted in real-time on mainstream markets.
The broad MSCI index-tracking ETFs, such as those developed by iShares and db x-trackers, or the similar Vanguard Emerging Markets fund, are huge, collectively holding more than £3.8 billion in assets.
A wide range of style biases and single-country ETFs, such as iShares' China, Brazil and Turkey funds, are also available.
Low annual charges, at around 0.36%, make ETFs only half as expensive as traditional passive equity funds, and just a fraction of the cost of actively managed equity funds.
There are compelling arguments favouring passive strategies where a market is enjoying astonishing secular growth, particularly where researching companies is not always easy.
But there is also an argument that in inefficient markets, where sense must also be made of 25 to 30 countries that are at different stages of development, a skilled active manager should be able to outperform the broad emerging markets indices, and that is borne out by the performance of unconstrained funds such as the Capital International fund.
The relaxation of the Ucits fund regime to allow greater use of derivatives, while maintaining all the advantages of daily liquidity and the inherent risk control structures, has been welcomed by some investment managers, such as the well regarded M&G Global Emerging Markets fund.
Many specialist investment trusts, particularly trusts with a bias to defensive strategies, have underperformed the market in recent months and are trading at heavy discounts to their underlying asset values, opening up the possibility of a double gain as their discounts to net asset value tighten.
VinaCapital's Vietnam Opportunity trust has performed well, making nearly 80% in the six months to September, yet is still on a discount of 33%.
"As trusts often trade on a discount, this plays out better in a rising market,' says Whiting. "Another key benefit of investment trusts is that they are closed-ended vehicles and do not need the daily liquidity required by Oeics and Sicavs, and this allows portfolios to drill down to lower liquidity stocks of the type that will grow 5, 10 or 20 fold."
The JPMorgan Emerging Markets Trust is around 10% to 15% invested in companies with market capitalisations of under $2 billion - significantly more than the small-cap weightings in corresponding Ucits portfolios.
Emerging markets' characteristic large trade surpluses, small government debts, large export sectors, high savings rates and readiness to allow their currencies to appreciate also add up to good conditions for bond buyers.
Some nations, such as Brazil and Russia, are now said to offer lower default risk than certain western countries. Brazilian government bonds currently yield 8.75% and settle in dollars, so provide an additional currency boost.
There aren't many emerging market debt funds available. Ashmore Investment Management runs offshore emerging market debt funds that are open to retail investors and Skandia has added the Goldman Sachs AM Emerging Market Debt fund to its Spectrum MultiManager range.
There are also bond ETFs such as the JPMorgan US$ Emerging Markets Bond Fund, traded on Arca, the NYSE electronic exchange.
Infrastructure is another way to access the industrialisation story. Jim Seymour, managing director of EMP Global, the private equity fund specialist, highlights the potential for power and logistics facilities such as warehousing and cold storage.
"I've been working in this industry since 1975 and this is indeed a tremendous opportunity for emerging markets. These markets are also at an advantage as they do not have a legacy of old decaying structures like the UK and Europe, and the demand and willpower is there," he says.
Another route to emerging market exposure is to buy individual shares with concentrated exposure to emerging markets such as City of London Investment Group and Ashmore Group, or US technology stocks such as Nasdaq-listed Qualcomm and New York-listed Micron Technology.
This article was originally published in Money Observer - Moneywise's sister publication - in November 2009
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
All investment returns are measured against a benchmark to represent “the market” and an investment that performs better than the benchmark is said to have outperformed the market. An active managed fund will seek to outperform a relevant index through superior selection of investments (unlike a tracker fund which can never outperform the market). Outperform is also an investment analyst’s recommendation, meaning that a specific share is expected to perform better than its peers in the market.
Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a “basket” of shares. There are generally two types of product, one offers income, the other growth and investors have to commit their capital for the prescribed term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
An account opened with a clearing bank (few building societies offer current accounts) that provides the ability to draw cash (usually via a debit card) or cheques from the account. Some pay fairly minimal rates of interest if the account is in credit. Most current accounts insist your monthly income (salary or pension) is paid directly in each month and they offer a number of optional services – such as overdrafts and charge cards – which are negotiable but will incur fees.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
A sophisticated absolute return fund that seeks to make money for its investors regardless of how global markets are performing. To that end, they invest in shares, bonds, currencies and commodities using a raft of investment techniques such as gearing, short selling, derivatives, futures, options and interest rate swaps. Most are based “offshore” and are not regulated by the financial authorities. Although ordinary investors can gain exposure to hedge funds through certain types of investment funds, direct investment is for the wealthy as most funds require potential investors to have liquid assets greater than £150,000m.
A bull market describes a market where the prevailing trend is upward moving or “bullish”. This is a prolonged period in which investment prices rise faster than their historical average. Bull markets are characterised by optimism, investor confidence and expectations that strong results will continue. Bull markets can happen as a result of an economic recovery, an economic boom, or investor irrationality. It is the opposite of a bear market.