Focus on emerging markets – Analysis of risk and reward

Small has been beautiful when it comes to emerging markets equities investing since the end of the global financial crisis and, perhaps surprisingly, it has also been less volatile.

It is perhaps not surprising that small cap emerging markets equities funds took six of the top 10 positions when the 1,313 EM funds in the FE GI Equity – Emerging Markets sector were ranked on three-year performance to 11 July 2012.

After all, smaller companies have a greater reliance on their healthy, local economies and are likely to be less exposed than larger rivals to, say, poorly performing western economies, as exports are likely to make up a smaller proportion of their business.

Instead, companies focused on their faster growing domestic emerging markets will have benefited.

But a review of performance and volatility of the FE GI Equity – Emerging Markets sector by FE also throws up some trends investors might not automatically associate with the best blend of risk and reward.

The analysis whittled down the sector to the top and bottom 10 funds on the basis of three year euro-denominated performance.

On performance alone, it is immediately clear that smaller companies provided better returns than, say income. Betting against emerging markets, via funds taking short positions, was also the wrong strategy.

More surprising, however, is the balance between reward from investing in smaller EM companies, and the risk investors took in so doing.

For data also suggest that not only have smaller companies provided better returns, they have also done so with less volatility risk than other investments, such as into income or value strategies.

What has worked for the likes of Danske Global Emerging Market Small Cap fund, is sectors such as consumer products and financials.

 

FE GI Equity – Emerging Markets 3yr return to 11 July 2012 (%)
Danske Global Emerging Market Small Cap A in EU 129.72
Aberdeen Global Emerging Markets Smaller Companies A2 USD in EU 121.99
ZI Aberdeen Global Emerging Markets Smaller Companies in EU 116.09
Trigon Russia Top Picks A EUR in EU 115.98
FPIL Optus Aberdeen GEM Smaller Cos in EU 111.75
FPIL Aberdeen Global Emerging Market Small Companies in EU 104.39
CFS Wholesale Global Emerging Markets Sustainability TR in EU 104.05
Aberdeen Emerging Markets Equity 1 in EU 95.22
Vontobel Fund Emerging Markets Equity B in EU 95.00
Emerging Markets Global Small Cap TR in EU 94.95

 

FE GI Equity – Emerging Markets 3yr return to 11 July 2012 (%)
Gem Emerging Income A1 04 in EU -85.95
Gem Emerging Value Opps S 5B2 in EU -82.19
ProShares UltraShort MSCI Emerging Markets TR in EU -69.52
ProShares Short MSCI Emerging Markets TR in EU -34.00
Gesmadrid Altae Bricc in EU -13.73
Caso Asset Management S.A. Malachit Emerging Market Plus in EU -11.78
Foncaixa Gartia Oportunid Emergente in EU -6.29
Prodigy Asia Emerging Markets in EU -5.80
STANLIB Africa Equity AU in EU -5.13
Imara Zimbabwe in EU -3.06

 

Reward vs risk Return %, 3yr to 30 June Volatility 
Top 3 by return    
Danske – Global Emerging Market Small Cap A in EU 119.23 16.39
ZI – Aberdeen Global Emerging Markets Smaller Companies in EU 102 15.4
Aberdeen – Emerging Markets Equity 1 in EU 81.22 n/a
Bottom 3 by return    
ProShares – UltraShort MSCI Emerging Markets TR in EU -69.63 59.5
Gem – Emerging Value Opps S 5B2 in EU -82.19 45.01
Gem – Emerging Income A1 04 in EU -85.95 44.07

 

Equities are only part of the story, however. There has been growing interest among investors in the West in partaking in the ‘EM story’ by buying into debt instruments, such as bonds.

The corporate issuers in the faster growing markets are in many cases running far better P&L’s than their western peers.

And as increasing numbers of bond issues from EM companies are rated in the ‘investment grade’ universe, there is a commensurate demand to buy, for example from liability-driven investors struggling with record low interest rates in developed markets.

An immediate point to note about the 495 funds in the FE GI Fixed Interest – Emerging Markets sector concerns the spread in returns between the top and bottom 10 funds – far more concentrated than for the EM equity funds universe.

Also, hardly any of the fixed interest funds have lost money for their investors over past three years.

Assuming default risk has been manageable, this suggests investors should perhaps have had far more exposure to fixed interest than equity, to increase the chances of positive returns.

On the issue of volatility, again the fixed interest universe does better. The spread of volatility scores between the top- and bottom-returning funds is less than in the equity universe. Given that that is the case, then it is important to compare the underlying holdings between the top and bottom funds.

For example, what has worked for the Pioneer Emerging Market Bond (Non Distributing) has been corporate and government bonds from markets such as Venezuela, Jamaica, Russia and Ivory Coast.

FE GI Fixed Interest – Emerging Markets sector 3yr return to 11 July 2012 (%)
Pioneer Lux Emerging Market Bond A Non Distributing EUR in EU 88.47
Pioneer Lux Emerging Markets Bond A Distributing Annually TR in EU 86.31
SEI Emerging Markets Debt Inst Acc GBP in EU 78.28
Aberdeen Global Select Emerging Markets Bond A2 USD in EU 75.48
FF Emerging Market Debt EUR TR in EU 75.46
T Rowe Emerging Markets Bond TR in EU 73.95
RS USD Aberdeen Global Emerging Markets Bond USD in EU 72.92
Ashmore Emerging Markets Liquid Investment Portfolio TR in EU 72.88
BlueBay Emerging Market Corporate Bond B USD in EU 72.25
KBC Bonds Emerging Markets Cap in EU 71.77

 

FE GI Fixed Interest – Emerging Markets sector 3yr return to 11 July 2012 (%)
Sogeval Eurovalor Garantizado Bric in EU -7.36
Gesbankinter Bric Plus Garantizado in EU -6.29
Popular PBP Bric Dinamico in EU 0.94
BlackRock Global Funds Local Emerging Markets Short Duration Bond A2 Hedged EUR in EU 2.58
KIC Bond Acc in EU 5.42
ING (L) Renta Emerging Markets Debt (LC) P Hedged Cap USD in EU 6.41
OFI Single Sel Stelphia Emerging Europe EUR in EU 6.61
Gutmann Emerging Markets Income Portfolio A TR in EU 7.14
Axxion Dual Return Vision Microfinance P EUR in EU 8.81
Wallberg Global Microfinance P EUR in EU 8.88

 

Reward vs risk Return %, 3yr to 30 June Volatility
Top 3 by return    
Pioneer Lux – Emerging Market Bond A Non Distributing EUR in EU 81.83 10.9
Pioneer Lux – Emerging Markets Bond A Distributing Annually TR in EU 79.55 10.81
SEI – Emerging Markets Debt Inst Acc GBP in EU 70.62 9.2
Bottom 3 by return    
Popular – PBP Bric Dinamico in EU 1.02 3.96
Gesbankinter – Bric Plus Garantizado in EU -4.77 6.2
Sogeval – Eurovalor Garantizado Bric in EU -6.14 7.86

 

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