Why is the emerging markets sector letting long-term investors down?
The emerging markets sector is known for its long-term growth prospects, but data from FE Analytics shows the performance of the sector over a ten-year period has been lacklustre.
Emerging market valuations are supportive of long-term results, as they have the potential to grow significantly faster than developed markets due to their population and demographic booms.
This growth backdrop argues for a structural long-term exposure in investor portfolios, and the coming decade should see decent growth in the market.
Contrary to this, data from FE Analytics shows the emerging markets sector has, however, been the worst performing equity sector over a five and ten-year period, with only a slight pick up over the last year.
The chart below shows the performance of the ACS Equity – Emerging Markets sector over a ten-year period relative to the global equities sector, Australian equities sector, and the best performer – the North American equities sector.
North American equities continue to be the best performing equities sector over a ten-year period, in part due to investors choosing the sector for its reliability following the Global Financial Crisis (GFC).
The caution exhibited by many investors post the GFC is to blame for the underperformance of emerging markets funds, which, historically, have tended to be unpredictable and more volatile.
The funds to beat the MSCI – emerging markets benchmark over ten years by the widest margin were Colonial First State’s (CFS) Global Emerging Markets Fund and Aberdeen’s Emerging Opportunities Fund. Both have made more than 100 per cent.
In fact, all three of CFS’ emerging markets funds have performed relatively well given the underperformance of the sector. Looking at the funds’ factsheets, it’s clear this is mainly due to their overweight allocation to consumer staples, which have surged over the past decade on the back of the market rally prompted by ultra-loose monetary policy.
The Wholesale Global Emerging Markets Fund holds over four times the 8.5 per cent benchmark weight of consumer staples, with a 34.9 per cent weighting to the stocks. They also hold a slight overweight in utilities at 5.3 per cent as opposed to the 3.2 per cent benchmark.
Consumer staples are known to provide investors with quality investments, and therefore consistent returns. The fund’s top holding is well-known global consumer staples company, Unilever PLC, with an 8.3 per cent weight awarded to the company.
Aberdeen’s Emerging Opportunities Fund also has a slight overweight in consumer staples (9.5 per cent as opposed to the 6.6 per cent benchmark) but has almost double the 23.8 per cent benchmark weight in financials at 44.4 per cent.
The chart below shows the performance of the top-performing funds relative to the MSCI benchmark and the emerging markets sector over a ten-year period.
The Schroder Global Emerging Markets Fund also topped the MSCI benchmark over a ten-year period, and over the shorter term, more funds have beat the benchmark, which shows an up-turn in the emerging sectors could be on the horizon.
OnePath’s Wholesale Global Emerging Markets Share was the worst performing fund at ten years but has jumped into the top quartile of the peer group over the past year. In its latest update, the fund said recent outperformance has been driven by its holdings in the basic materials and consumer staples sector.
Legg Mason’s Martin Currie Global Emerging Markets Fund has beaten the index over the shorter term, placing first over a three and one-year period. It suffered a drawdown around six months ago, placing 25th of 45, but rose to third over three months and second over the last month.
The chart below shows the performance of the four top-performing funds over the last three years relative to the sector.
Looking at a one-year history of the sector, eight of 45 funds have outperformed the benchmark, which equates to almost 18 per cent of funds in the index, an increase of 11 per cent from the three funds that outperformed the benchmark in 2008.
This suggests that despite remaining one of the worst-performing sectors, there may be a turning point in sight.
According to Schroder’s head of emerging markets equities, Tom Wilson, global growth is expected to be sustained in 2018, which should continue to support global trade – a positive for emerging markets.
Wilson predicted China’s economy would expand but at a slower pace, referencing a “tightening of monetary conditions” as the cause.
This would likely act as a modest drag on global trade, and a hindrance to the performance of emerging markets funds.
Russia and Brazil, on the other hand, are expected to continue economy recovery with lower interest rates and low inflation stimulating consumption and investment.
Wilson said on a relative basis, valuations remain attractive, but there is limited prospect for multiple expansion in the next 12 months.
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