Play the long game in emerging markets

9 March 2016

Investment returns from emerging markets have hardly been covered in glory over recent years with many investors nursing significant losses. In 2015, the MSCI Emerging Market index, which tracks stock markets across developing nations, bombed by 10% and over the past three years it is off by 21%.

However, one school of thought argues that those of an intrepid disposition, prepared to buckle up for the long run, should view this as a buying opportunity, given that the sector is so out of favour.

Read Why you shouldn't time the market

Putting losses into perspective

China, the world’s biggest emerging market and widely viewed as a major driver of the global economic engine, has been at the centre of the trouble. Economic slowdown and transition in the world’s second largest economy, the US, has hit it, and its emerging market neighbours, chiefly as a result of slowing Chinese demand for commodities and lower trade activities.

However, while China’s economic growth rate pulled back last year, it still grew by 6.9%, compared with 7.3% a year earlier. As such, it is hardly slouching: according to the last official tally, it was growing at an annual rate of 2.1%.

Emerging markets, after all, are nations whose economies are growing at a faster pace than advanced economic countries such as Britain or the US. They are typically experiencing rapid industrialisation and are characterised by a young, growing workforce and a rising middle class.

The world’s primary emerging markets include Brazil, Russia, India and China, collectively referred to as the ‘BRICs’. Together, they account for a massive 40% of the world’s population and house an abundance of natural resources.

As they grow and prosper it is anticipated consumer spending will rocket, which will in turn deliver ever-stronger investment returns.

What's gone wrong?

The poor performance across emerging markets has been in the wake of a combination of factors.

For one, the price of commodities, most notably oil, has continued to fall dramatically. The upshot of this has been that many commodity-dependent developing market companies have fallen in value.

In addition, higher interest rates in the US, as well as a stronger dollar, have been particularly hard for natural-resources-reliant countries, as commodities are largely priced in US dollars so are negatively impacted by the more robust currency. Most emerging market companies tend to borrow in US dollars too, so that an increase in the dollar’s value, means a higher level of debt.

This backdrop has been exacerbated by the usual factors that tend to characterise emerging markets, namely political risks, sub-standard infrastructure and poorer levels of corporate governance.

The upside

But despite the current woes engulfing the sector, some believe the long-term case for investing remains.

The thesis backing the investment case asserts that ultimately growth across emerging markets continues to beat that in the Western world, and economic prospects should benefit from greater domestic consumption over time.

However, investors need to be prepared to tolerate some extreme market swings. Taking a short-term bet could be like trying to catch a falling knife, so investors need to be ready for a long-term commitment.

Patience could prove lucrative, though, given that over the past 15 years, the MSCI Emerging Markets index has risen by 180%.

David Coombs, head of multi-asset investments at fund manager Rathbones, expects there will be more pain to come but he believes the “long-term story remains”.

Four emerging markets funds to consider

Standard Life Investments global emerging markets equity

Size: £130m; launch date: May 2012. Reasons to invest: Patrick Connolly, a certified financial planner at Chase de Vere, highlights that the fund’s manager Alistair Way has a lot of flexibility as he is not limited to investing minimum amounts in any country or sector.The portfolio has investments across a wide range of countries including China, Korea, Mexico and Thailand.

Threadneedle global emerging markets equity fund

Size: £188m; launch date: March 2006. Reasons to invest: Managed by Irina Miklavchich, the fund has investments in countries such as the Philippines, Russia and India. Gavin Haynes, managing director at Whitechurch Securities, says: “Threadneedle has a well-resourced, experienced team focusing on well-managed companies with sustainable business models.”

JPMorgan emerging markets income fund

Size: £260m; launch date: July 2012. Reasons to invest: Adrian Lowcock, head of investing at Axa Wealth, recommends this fund for yield-hungry investors. He says: “Its manager Richard Titherington runs a flexible income fund and will invest in both defensive and higher-risk stocks.

This ability to tilt the portfolio helps the manager deliver strong performance while maintaining a high yield.”Taiwan and South Africa count among its bigger bets.

Lazard emerging markets fund

Size: £708m, launch date: 1997. Reasons to invest: Managed by James Donald, the fund has investments across, among others,Taiwan, China, Korea and India. Darius McDermott, managing director of fund broker Chelsea Financial Services, says: “The manager employs a strong value investment* discipline, which has led to this being one of the stand-out funds in its sector.”

* Value investors actively seek stocks of companies that they believe the market has undervalued.