Brewin Dolphin: Passive Funds Work in Emerging Markets

Against conventional wisdom, Brewin Dolphin's Ben Gutteridge says he is becoming a believer in passive investing in emerging markets

David Brenchley 7 December, 2017 | 3:38PM
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The BATs look "extremely investable", says Brewin Dolphin.

Investors are increasingly choosing passive solutions when allocating capital into emerging markets, according to strategists. Private and professional investors alike have turned positive on the sector after a stellar 2017.

Generally, the fortunes of emerging markets have ebbed and flowed on the whim of commodities markets. Hence, when the oil price crashed in 2014, so did emerging markets equities.

This year, the oil price has stabilised. That, alongside a deterioration in the US dollar, has given emerging markets renewed confidence - but commodities are no longer the key driver of emerging markets.

The Changing Face of Emerging Markets

The MSCI Emerging Market Index has powered ahead since hitting a seven-year low early 2016, thanks to a few powerful Chinese names in the technology space. Carlos Hardenberg, manager of the Templeton Emerging Markets Investment Trust (TEM), likely to be tech, rather than commodities, that affects the index in future.

"We are seeing the cultivation of a new generation of innovative companies located in emerging markets,” he explains. This is diversifying their economies and the opportunitie set for investors.

A comparison between the emerging market index in 2011 and today illustrates this changing of the guard. Six years ago, the information technology sector accounted for around 13% of the index, according to Franklin Templeton. Now, it accounts for more than a quarter.

Three of the four most valuable emerging market companies in 2011 were resource-based. A further three were financials, alongside two telecoms firms and two tech giants in Samsung (005930) and Taiwan Semiconductor (2330).

Today’s list contains seven tech companies, including China’s BATs – Baidu (BIDU), Alibaba (BABA) and Tencent (00700) – and South Africa’s Naspers (NPN), which many see as a proxy for Tencent. “That collection of businesses looks extremely investable to us,” says Ben Gutteridge, head of fund research at wealth manager Brewin Dolphin.

As a result, Gutteridge says he now favours passives as a large-cap emerging market strategy, as the index weighting is the weighting a canny investor would want to replicate.

“The index is dominated by the large companies and those businesses are earning well and doing a very good job at this juncture,” he explained.

This view goes against the generally accepted wisdom that, due to inefficiencies in emerging markets, active managers should be better placed to outperform indices.

Active EM Funds to Add Value

However, Gutteridge admits Brewin’s strategy has not done away with active funds entirely. In some places, active fund managers can add value, particularly down the cap scale to smaller sized companies.

Having switched into emerging markets earlier this year, Guy Foster, head of research at Brewin, says, as contrarian investors, expects his team’s biggest positioning decision in 2018 is “being able to escape from the very crowded areas of Europe and emerging markets before a growth wobble” in China.

A slowdown in Chinese growth being the base case, Gutteridge says two of his fund picks are more defensive in nature.

A recent addition to Brewin’s fund list is Morgan Stanley Asia Opportunities, which has only been around since March 2016. However, it had returned a healthy 35.78% as at 30 September 2017 compared to its MSCI All Country Asia ex Japan benchmark’s 22.25%.

“It has some of this tech disruptive play, but it’s predominantly a defensive consumer play,” Gutteridge explains. While its two largest holdings are Tencent and Alibaba, it’s actually underweight the IT sector.

It has big overweights to the consumer discretionary, consumer staples and healthcare sectors, holding soy sauce manufacturer Foshan Haitan Flavouring (063288), pharma Jiangsu Hengrui Medicine (600276) and wine maker Jiangsu Yanghe Brewery (002304).

“It’s not a million miles away from the funds that have been the rewarders of the past,” adds Gutteridge. “When you’ve had growth issues the consumer staples have done well.”

He also likes Fidelity Emerging Markets, a Morningstar Bronze rated fund run by Nick Price. Its top two holdings are Naspers and Taiwan Semiconductor. They account for almost 14% of the fund’s £2.3 billion of assets. Other top positions include financials AIA (01299), HDFC Bank (500180) and Sberbank of Russia (SBER).

While they are attempting to position themselves to exit emerging markets at the opportune time, Foster acknowledges that there will be a time down the line when an opportunity will come up to get back in.

Gutteridge says that a “hedge against much better outcomes for emerging market growth than we’re anticipating” is Morningstar Bronze Rated M&G Global Emerging Markets, run by Matthew Vaight.

Vaight tells Morningstar he believes people are paying too high a price for quality characteristics. "Yes, I have some exposure to quality names, but they aren't consumer staples. Instead I look for quality industrials, quality financials, quality materials names."

He says the most exciting part of his portfolio lies within those more value-based companies that have a low return on capital today but can grow that in the future.

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David Brenchley

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