Rapid rates of growth in emerging markets have seen a whole host of investment sectors including manufacturing, financial and domestic consumption flourish in the last 15 years or so. Returns from emerging markets funds have been very strong as a result, and unsurprisingly investors today are keen to get a piece of the action.
Performance of sectors and index since Dec 2000
Source: FE Analytics
There are mounting concerns over emerging markets at the moment, however, with some experts forecasting a serious crisis in countries such as China and Brazil in the near future.
On a longer term view, even more worrying, arguably, are the structural changes that have occurred in emerging markets in recent years, which will see future returns much lower than in the last 15 – even if the asset class does indeed avoid a major crisis.
Emerging markets managers have themselves commented on this trend.
"Emerging markets are very different to what they were five or 10 years ago. Returns from hereon in will be lower in the next 10 years compared with what we’ve had since 2000, as markets are now more fundamentally driven," said Edward Lam (pictured), manager of the five-crown rated Somerset Emerging Markets Dividend fund.
"We’ll see less in the way of multiple expansions and more in dividend and earnings growth, as these economies are now more developed." For investors looking for a fund to invest in in the long-term, this presents a potential problem. Here are two potential alternatives for those worried about the trend.
Cazenove UK Smaller Companies
The obvious alternatives to emerging markets for UK investors are UK small cap funds, which are viewed as long-term, volatile investments with huge potential for capital growth.
The organic growth of companies ensures that the small cap universe is permanently updated with new opportunities for managers. The opportunity for finding fast-growing companies, therefore, is ongoing.
There are a whole host of funds to choose from in the IMA UK Smaller Companies sector, but arguably the standout performer in recent years is the Cazenove UK Smaller Companies fund, run by Paul Marriage.
The FE Alpha Manager is entirely bottom-up in his approach, ignoring macro noise when he puts his portfolio together. Marriage and co-manager John Warren consider valuation when they pick their stocks, but are not afraid to hold “expensive” companies if they think they can continue to grow their business.
He invests very low down the market cap scale, rarely delving into the mid cap market to find ideas. Top-10 positions at the moment include Marston’s Brewery, Premier Foods and cable maintenance company Hellermann Tyton Group.
Marriage’s approach has paid off handsomely: the fund is a top-decile performer in its sector over three, five and 10 years and is still well ahead of its sector and FTSE Small Cap benchmark over the last 12 months.
Performance of fund, sector and index over 5yrs
Source: FE Analytics
Cazenove UK Smaller Companies is rated highly by Rob Gleeson and his FE Research team, who include it in their FE Select 100 list. They particularly like the fund’s ability to protect against the downside, which is unusual for a small cap portfolio.
"Warren and Marriage have delivered consistent returns without taking on an unnecessary amount of risk," they said.
"The fact that the portfolio managed to protect investors’ capital in the falling market of 2011 makes it appealing, as this is not what is usually expected from a smaller companies fund."
"Marriage is a passionate fund manager who demonstrates a genuine interest in the companies he invests in. The addition of Warren in 2010 as co-manager was a positive move and the fund will benefit from his accounting expertise."
The team adds that the fact the duo run a long/short fund is a bonus, as it has improved their sell discipline.
The five crown-rated fund requires a minimum investment of £1,000 and has ongoing charges of 1.61 per cent.
Investors interested in the fund will have to be quick: due to vast inflows and concerns over capacity, the fund will close to new investors on 22 January 2014. Until then, it remains open on all major platforms.
F&C Global Smaller Companies Trust
For those looking for an investment trust, only one global small cap trust stands out: the F&C Global Smaller Companies IT, which is run by the highly experienced Peter Ewins.
The £405m trust invests predominantly in developed equities, but can invest in emerging markets if the manager sees adequate opportunities. The US and UK currently make up the bulk of regional exposure, with Europe a distant third.
Ewins tends to invest directly in companies, but gets some of his exposure via other investment vehicles. The M&G Japan Smaller Companies fund is currently his biggest single holding, for example, at 3.8 per cent.
Since taking over the trust in early August 2005, Ewins has consistently beaten his peer group and composite benchmark – split 70/30 between the MSCI World Small Cap ex UK and Numis Smaller Companies ex IT indices.
FE data shows it has returned 183.56 per cent over this time. It is also well ahead of its sector average and benchmark over one, three, five and 10 years.
Performance of trust and index since Aug 2005
Source: FE Analytics
The trust has a healthy income record too, raising its dividend in each of the last 43 years. It is currently yielding 0.78 per cent.
Both volatility and max drawdown have been higher than the benchmark under Ewins, but the manager points out that he has a very long-term approach and is prepared to be patient with underperforming positions.
Ewins said in a recent note to investors: "Given liquidity issues it is important to take a long-term view on investments in this area, and to focus on companies with the ability to generate positive internal cash-flow to allow them to develop successfully in the future."
F&C Global Smaller Companies Trust has an ongoing charge of just 0.76 per cent, but it does charge a 10 per cent performance fee on all returns in excess of its benchmark.
It is currently on a very slight premium, but uses a discount control mechanism (DCM).
