Annie Shaw uncovers those trusts offering access to the substantial growth predicted for emerging markets.

Investors, battered by poor stock market returns, have been looking outside their traditional comfort zones in search of better prospects. This quest has been taking them out of more familiar vehicles, such as UK tracker funds, and into overseas markets. One of the simplest ways to do this is via investment trusts.

James Saunders Watson, head of sales and marketing at J.P. Morgan Asset Management, says, ‘We are constantly being told that the death knell is about to be rung for investment trusts, but it doesn’t happen because investment trusts can always find a place in a portfolio.’

Malcolm Dodds, head of platform development and investment trust services at Alliance Trust Savings, agrees. ‘We continue to see increasing demand for investment trusts on our platform. This quarter we saw record net purchases of investment trusts – the third successive quarter that this record has been broken.’

Investment trusts have indeed proved resilient during the downturn, giving better returns than their open-ended counterparts, unit trusts and open-ended investment companies (OEICs).

According to figures from data analyst Morningstar, although the Foreign & Colonial Investment Trust – the grand-daddy of them all, which pioneered the concept of collective investments back in 1868 – lost 13 per cent of its value over the past year, during a period of huge stock market upheaval, it was still up 54 per cent over five years. Alliance Trust itself fell just 4 per cent over the year, yet it was still up 34 per cent over five years.

In the Global Growth sector, investment trusts have returned £1,490 after five years from an initial £1,000 investment and £1,530 after ten, compared with £1,248 and £1,094 for open-ended funds.

Looking at the options
Ben Yearsley, an investment manager at Hargreaves Lansdown, suggests, ‘Investment trusts are no better or worse than unit trusts – and there is more choice in unit trusts – but the advantage of investment trusts is that they can trade at a discount to net asset value. Of course, this means some also trade at a premium, but if you choose well you can take advantage of the possibility of trading at a discount.’

He cautions against selecting a trust simply on the grounds of a discount, and advises potential investors to look at the underlying reasons for this. ‘You need to check why the trust is trading at a discount, because it might be because of poor management, but just now, with the credit crunch, there has been a lot of cashing in by investors, creating discounts on sound companies.’

Ready to react
The flexibility offered by investment trusts means they are ideal vehicles to take advantage of an upturn in world stock markets. Managers are well aware of this, and there has been a flurry of fundraising in the sector to take advantage of the anticipated recovery.

Says Saunders Watson: ‘Closed-ended funds are more suited to more esoteric markets, such as emerging markets in the Far East, where future opportunities are likely to lie.’

He gives the example of a manager who operates both closed-ended and open-ended funds with similar names. ‘They will both have a similar mandate,’ he explains, ‘but you will find that the closed-ended fund will have different holdings, particularly in a higher-risk fixed pool of assets, rather than more liquid assets, which would be required for an open-ended fund to cope with investors cashing in.’

Eyeing up the prospects
So, having identified the benefits of investment companies, where should an investor look for the best return?
While the big global funds are a popular choice, attention is turning increasingly to emerging markets for the biggest opportunities. Templeton Emerging Markets came top of Alliance Trust’s most recent table of the biggest gainers over the first quarter of 2009, jumping up to number four in the table after Alliance Trust itself, RIT Capital Trust and Edinburgh Investment Trust.

The investment philosophy of Mark Mobius, executive chairman at Templeton Asset Management, is one of ‘value, patience and fundamental research’. He enthuses, ‘Our adherence to value means that we seek to invest in companies that our research indicates are undervalued compared with what we believe they may be worth. As patient investors, we evaluate companies on a five-year investment horizon and focus on long-term fundamental potential, not on short-term fluctuations.

‘Although [in the past three months] we are leading the [MSCI Emerging Markets] index, we don’t measure ourselves against the performance of the index. Our main objective is to have positive long-term returns.’

While some commentators are warning of a possible 20 to 30 per cent correction in global equity markets, which could affect the fund adversely, Dr Mobius is unfazed. In a recent briefing to celebrate the 20th anniversary of the trust, he said, ‘Emerging markets are still outpacing the developed countries, even though we’ve had a downturn. Next year, emerging markets are expected to grow on the average of about 2 to 3 per cent, whereas the developed countries will probably have an average growth of zero. The next thing that’s important to note is that the largest and most populous countries in the world – China and India – are the fastest growing, and this year China is predicted to grow 8 per cent, while India is predicted to grow 6 per cent.’

He adds, ‘A correction of 15 to 20 per cent is nothing. But the long-term trend will be up – there is no doubt in my mind about that.’

Away from the West
Baillie Gifford’s Scottish Mortgage Trust has also turned to emerging markets in search of profits. In the six months to the end of May, the share price rose by 56 per cent, and its net asset value rose 41 per cent, beating the benchmark FTSE All World index, which was up 29 per cent.

Sir Donald MacKay, the trust’s chairman, explains, ‘A central strategic thesis that countries outside the Western economic block will become increasingly and possibly rapidly influential appears strengthened.’

Hugh Young, managing director of Aberdeen Asset Management Asia, not unnaturally thinks Asia has a lot to offer: ‘Asia is suffering with the rest of the world, but its financial conservatism places it in a good position to come out of the global recession with greater standing.

‘For now, we face a waiting game. We could be a year away from sustainable equity market recovery – rather than the holding pattern I see us in now. Pending that, shares may stay volatile. The best strategy during these times may be for the individual to drip feed money into markets. When the recovery does come, I’m sure we will only know afterwards. I’m equally sure Asia should come out of today’s problems sooner and in a much better position than the West.’

Aaron Gurwitz, head of global investment strategy at Barclays Wealth, suggests, ‘Rather than buying an index, we advocate active management in Asia or “thematic” portfolios, such as infrastructure. Investors can also consider Western companies with high levels of Asian revenue.’

Growing popularity
For funds that are heavily weighted or dedicated to one country or regional funds, Saunders Watson recommends China, as does Donald MacKay, who says, ‘The continued growth and increasing importance, and even dominance, of non-Western economies, especially China, represent a major opportunity for shareholders.’

Templeton’s Mobius likes the look of Russia stocks: ‘Some of them are inexpensive. The assets are quite undervalued, but business is down for a number of companies, and some of them are heavily in debt. At the same time, we are finding some companies that are structurally in good shape. The market generally is cheaper than other markets.’

Other emerging areas of Europe are also attractive. Baring Asset Management and BlackRock both have funds that cover these. J.P. Morgan’s James Saunders Watson explains, ‘People tend to take a political view of the area rather than look at the economic element. It is possible to make a lot of money out of Europe, and there are a lot of opportunities in the small-cap space.’

Looking to Latin America, Saunders Watson calls Brazil the ‘sleeping giant’ of emerging markets, while Devan Kaloo, head of global emerging markets at Aberdeen Asset Management, says, ‘Brazil continues to be one of our favoured emerging markets. Longer term, the economy and various companies – in particular, financials and consumer-related businesses – will benefit from a young, educated workforce.’