Guide to emerging markets

Between 2000 and 2008, emerging economies contributed 40% of world growth. And in the five years from 2009 to 2014, their share of global growth will leap to more than 60%, according to research from Neptune Investment Management.

While Western economies struggle under the burden of huge personal and government debt, emerging economies are in robust financial health.

The reasons are familiar. Emerging markets' populations are growing in size and wealth, fuelling consumer demand. And emerging market governments are using their relative wealth to invest heavily in infrastructure and other capital projects, not only stimulating economic growth but also making it easier to do business in these countries.

Commodities are also important, with Latin America, Russia and Africa all rich in the raw materials that India and China, in particular, need for their economic growth.

An expanding market

Little wonder, then, that investment interest in emerging markets is soaring. As such, it is also the area attracting most new fund launches. Among recent activity, Jupiter has just launched a global emerging markets fund, BNY Mellon a Latin American Infrastructure Fund, Allianz a Brazilian one, and earlier this year JP Morgan launched both an emerging markets investment trust and one specialising in Brazil.

The dramatic growth in the number of vehicles means investors now have a bewildering choice of ways to tap into the market. A decade ago, there was only a handful of global emerging market or Asian funds, and a few country funds.

Today, investors can choose from BRIC (Brazil, Russia, India and China) funds, Africa, Latin America, Asia and emerging Europe funds, income funds and infrastructure funds – and there are even some fixed interest and currency funds.

Sustainability, climate change and commodities funds also depend heavily on emerging market growth. So, how should investors choose between them? Most advisers agree that all investors should have some exposure to emerging markets.

Tim Cockerill, head of funds research at Ashcourt Rowan, says that while the recent strong run in emerging markets means that returns may be more pedestrian in the immediate future, "over 10 years, that will make no difference. Long term, investors will have to have exposure to the region".

The best starting point is a general emerging market fund. Countries and regions swing in and out of favour. Brazil and Turkey are among recent hotspots, while Russia has lagged a bit due to the financial crisis. Global fund managers switch between regions as the outlook changes.

For those willing to take more risk and bet on which region will perform best, there is a wide range of regional funds specialising in, for example, emerging Europe, Africa and the Middle East. Given the relatively undeveloped nature of stock markets in regions such as the Middle East, though, it must be seen as higher risk.

There are also some funds that invest in the BRIC regions, seen as offering the best combination of demographics and increasingly affluent populations.

But the performance of the main fund in this area – Allianz RCM BRIC Stars – has been pedestrian and most global emerging market funds will have a heavy weighting to these four countries.

Riskier still are single-country funds, where investors are more exposed to the vagaries of government policies and to a small number of companies – many emerging markets are dominated by just a few large companies.

Single-country funds often top annual performance charts but are equally likely to be propping up the bottom. They should, therefore, be seen as additions to a large emerging market portfolio rather than the first step into the sector.

Increasing income

Traditionally, emerging markets have been about growth rather than income but that's changing. Companies are becoming more shareholder-friendly and putting some of the cash they generate into dividends. That has promoted a number of emerging markets income funds.

Kathryn Langridge, who will manage Jupiter's new Global Emerging Markets fund, says she puts a lot of emphasis on dividends as evidence of balance sheet efficiency and good cashflow.

For investors seeking income, emerging market income funds offer a good way of diversifying from the UK, where the concentration of dividends in a few sectors has increased risk. But they are likely to be more volatile than UK funds, both in capital and income returns. 

Simon James, a partner at Gore Browne Investment Management, thinks currency will become a factor for emerging market investors over the medium term. "As [emerging] economies strengthen, so will their currencies, while the flow of money into them will also help," he says.

Given the scale of investment by developing countries, infrastructure funds seem a natural diversification. BNY Mellon is launching an infrastructure fund focusing on Latin America and says the region has among the highest levels of infrastructure investments worldwide, with more than $450 billion (£279 billion) of projects planned until 2015.

First State also has a global infrastructure fund, while Utilico Emerging Markets, a Bermuda-based closed-end investment company, invests in utility and infrastructure companies in developing regions.

Most fund management houses have at least one type of emerging markets fund but there are some acknowledged specialists in the region. First State, Aberdeen, Schroders and JP Morgan have been offering emerging market funds for some time and have a wide range of products available.

Among the newer entrants, Neptune has carved out a particularly good reputation, while Barings also has considerable expertise.

This article was taken from the December 2010 issue of Moneywise's sister publication, Money Observer