The MSCI Emerging Markets index has lost money so far this year while developed markets such as the US and the UK have made double-digit returns, according to data from FE Analytics.
Performance of indices year to date
Source: FE Analytics
Emerging market bulls say that although the developing world is facing headwinds such as the end of QE, a strong US dollar, falling commodity prices and current account deficits, it is only a matter of time before the sector starts to focus on the fact that it is very cheap compared with its history.
City Financial’s Mark Harris, who currently has very limited exposure to the developing world, recently told FE Trustnet that he wold "jump" into emerging markets funds if they were to fall a further 10 per cent.
There is also the argument that improving sentiment in the developed world will eventually feed back through to the emerging markets, making today’s valuations particularly enticing.
This raises the question of how best to pick a fund to take maximum advantage of this reversal.
One method, in theory, is to look at the performance of emerging markets funds in previous periods of recovery to see how they did.
The last time emerging markets saw a recovery from a sharp slump was 2009.
The world had seemingly been in financial meltdown just months before, with the collapse of Lehmans, but then rebounded, with the MSCI Emerging Markets index returning 60 per cent that year.
The emerging markets funds that benefited the most that year were the portfolios that focused on more volatile areas.
For example, Richard Sneller’s £508m Baillie Gifford Emerging Markets Growth fund returned a staggering 78.66 per cent in 2009, while Aberdeen Global Emerging Markets Smaller Companies and Templeton Global Emerging Markets both returned more than 70 per cent as well.
Also, higher risk funds such as country-specific portfolios were market leaders that year.
According to FE Analytics, FE Alpha Manager Oleg Biryulyov’s JPM Russia fund made more than 130 per cent in 2009 and FE Alpha Manager Robin Geffen’s Neptune Russia & Greater Russia fund returned 116.03 per cent, but as the graph shows, the overall market also performed strongly.
Performance of funds vs index in 2009
Source: FE Analytics
Other single-region portfolios such as Indian, Latin American and emerging European funds all performed strongly as well.
However Ben Willis (pictured), head of research at Whitechurch, says the next rebound in emerging market equities is likely to be different to what has gone on before. "At that stage (during 2009), people began to realise that it wasn’t the end of capitalism and they started buying anything that was excessively cheap, so not just emerging markets, but areas like UK smaller companies," Willis said.
"What you haven’t got this time is the mass repulsion of equity markets which we had seen before, but instead we have the real disparity in sentiment between emerging and developed markets."
"In 2009, once everyone had realised that it wasn’t the end, there was a wholesale shift into equities so the higher-risk areas that had been hit the hardest in the crash bounced back from even lower levels."
"This time around, I think it is a bit more of a different scenario," he added.
Instead, Willis says investors who are looking for the strongest returns in a rebound could look towards the more prominent emerging markets, as the likes of China or India are going to be the more likely drivers of a turnaround in sentiment.
"You could start looking at the BRICs. Even with China, though there has been a lot of bad news surrounding it, Chinese equities have still returned around 20 per cent over the last year," he said.
"If there were to be a rebound, these would probably be the areas to look for growth. India is looking interesting again as it is so cheap and Brazil has gone under the radar so far. It could be that a collective BRIC fund could be the best way," he added.
For anyone who agrees with this point of view, one option could be Dr Mark Mobius’ $1.3bn Templeton BRIC fund. It has performed strongly in rising markets in the past, although the recent period of bad performance in emerging markets means it is down over one, three and five years.
Willis admits that this may seem like quite an unattractive strategy, but adds that there is an alternative option available.
He says that investors who are really bullish on a rebound in emerging market equities should consider investment trusts, as not only could they see the benefits of the trust’s NAV rallying, but the current wide discounts on closed-ended emerging market funds could narrow significantly.
He says this is an approach that is only suited for more aggressive investors, but adds that the so-called "double-whammy" could be a particularly fruitful strategy.
The vast majority of the trusts in the IT Global Emerging Market Equities sector – with notable exceptions including BlackRock Frontiers Investment Trust and JPMorgan Global Emerging Markets Income Trust – are trading on a wider discount than their one- and three-year averages.
For example, Genesis Emerging Market is the best-performing trust in the sector over 10 years, with returns of 370.45 per cent, almost 150 percentage points more than the MSCI Emerging Markets index.
Performance of fund vs index over 10yrs
Source: FE Analytics
Despite that performance, it is trading on a discount of 7.98 per cent at the moment, while over the last year its average has been close to 5 per cent and over three years it has been close to 6 per cent.
Genesis Emerging Market is not geared. It has ongoing charges of 1.69 per cent.
