The Global Emerging Markets sector remains relatively small in terms of the overall open-ended fund universe but one that has been punching above its weight in recent years, at least in terms of performance.

Funds in this sector invest primarily in emerging markets. The sector definition is fairly wide (see box on page 60).

A broad choice
This gives a broad universe to choose from – Dr Mark Mobius, Franklin Templeton’s revered head of emerging markets, reckons there are between 50 and 60 different markets that his team can consider.

There are currently 34 funds in the sector, including institutional funds. Indeed, one of the best funds according to the Lipper Leaders process is Fidelity’s emerging markets fund, which is currently only available to institutional investors. These range from genuinely broadly diversified global portfolios to funds with a specific geographical focus. There is no explicit restriction on the amount that can be invested in any one qualifying market, although single-country emerging market funds, or those that concentrate on a particular theme or sector will be listed in the Specialist sector.

For all that the sector offers a global reach, the concentration of most portfolios tends to be in any or all of three main areas – the Far East, emerging Europe and Latin America – and the bulk of the generalist portfolios will be invested in these regions.
Indeed, there tends to be a concentration on a core group of markets within each region. China, either directly or via shares listed in Hong Kong,
has become an increasingly important element in most portfolios, with the Asia Pacific weighting of most funds generally being dominated by this market alongside Taiwan, Korea and, increasingly, India. Latin America tends to mean Brazil or Mexico, while the emerging European element has been mainly Russia and the more advanced recent members of the EU – Poland, Hungary and the Czech Republic.

Not that other markets are excluded, but it is the larger and more established markets within this universe that tend to provide the core holdings for most funds.

Balancing risk and reward
There is a trade-off between wanting to participate in the growth potential of genuine ‘frontier’ markets and a desire to limit risk. Lack of liquidity, poor corporate governance, even difficulties in asserting ownership rights are all hallmarks of markets in the early stages of development, so there is a tendency to prefer markets that have emerged far enough for investors to buy and sell their holdings when they want to.

Similarly there are differing degrees to which emerging markets are open to foreign investors. In most emerging markets, particularly in their early stages, there are likely to
be restrictions on what type of shares overseas investors can buy, how much of a company they can own and how they can realise their investment, although, again, these tend to relax as their economies mature.

Partly for this reason, the managers of emerging markets funds rarely limit themselves to simply buying the shares of companies listed in these markets. A significant part of many portfolios will be invested in companies based elsewhere but largely conducting their business in an emerging market and they frequently use American Depositary Receipts (ADRs), which are issued by companies based in emerging markets as a means of raising capital in the US market, as these are often viewed as a more liquid, not to say secure, way of getting exposure to emerging market companies.

The general rule is that, the more developed and liquid the market, the more likely that fund managers will be investing directly; but with some of the newer, more restricted markets, they may well opt to invest via other companies, specialist funds focusing on those markets or ADRs.

Growth and volatility
Above all, emerging market investment is about growth. The yields on these funds are generally low, although dividends are becoming more common in many of these markets, particularly in the Far East and Eastern Europe. Returns can also be extremely volatile, reflecting the fact that emerging market investing carries a higher-than-average level of risk.

The Lipper Leaders analysis on page 61 shows no qualifying Leaders for Capital Preservation. In fact, none of the sector’s constituents came close, with no fund scoring higher than 3 in this category for any period. This simply reflects the volatile nature of the underlying markets.

The spread of returns can also be significant. Although all funds in the sector are in positive territory at the moment, the gap between the best and worst over six months is more than 23 per cent, an extremely large gap over such a relatively short space of time, reflecting the importance of picking the right manager in this highly specialist field.
Fund data service Financial Express reports that the sector’s average volatility is 17.2 per cent, which is relatively high, and that the individual funds in the sector have volatility figures ranging from 15 to 22 per cent, suggesting that this is something investors have to put up with in this sector, rather than the result of any particular management style.

This volatility is an inevitable consequence of investing in emerging markets. It is not made any easier by the addition of currency risk. Funds may be investing across a number of different currencies, with varying degrees of stability and, in some cases, restrictions on exchange. This is another reason why some managers favour using US dollar-denominated ADRs, which limits the currency risk to the dollar, although in recent months that has created difficulties of its own.

One of the key themes at the moment is the dramatic growth of China and India, and its consequent effects on demand for global commodities. Indeed, many global emerging markets funds have become secondary plays on natural resources companies, particularly those with a relatively high exposure to Russia.

Another complicating factor is that a number are relatively recent launches. For example, Mark Mobius’s team at Franklin Templeton do not figure in the Lipper Leaders analysis as their UK open-ended fund, Franklin Templeton Global Emerging Markets, was only launched in March 2004 (so only qualified for one period), even though their investment trust has built up an impressive track record in this area over more than 20 years.

Gartmore Emerging Markets Opportunities
Launched in 1987 and now some £360 million in size, this fund is one of the longest-established in the sector. It was also one of the first to invest in China, although its Chinese weighting (11.8 per cent) is currently only its third-largest, behind Brazil (15.8 per cent) and Korea (13.2). The current manger, Chris Palmer, originally took over in 1995 and came back to the fund 18 months ago after a two-year break.
The fund makes full use of the flexibility available to it, including using ADRs and investing indirectly through holding companies and investment funds.

Baillie Gifford Emerging Markets Growth
Baillie Gifford’s emerging markets fund was launched in 1997 and is one of the largest in the sector at £900 million. Baillie Gifford has built a particular reputation for investing in the Far East, but this fund is broadly spread through the emerging markets universe, although its major country weightings are to Korea (18 per cent) and China (15 per cent). Managed jointly by Richard Sneller and Gerald Smith,
the fund takes an active and flexible approach to its sector allocation, with its current largest holdings being Brazilian oil company Petrobras (4.5 per cent) Korean electronics giant Samsung (3.7 per cent), Russian gas monolith Gazprom (3.1 per cent) and Indian conglomerate Reliance Industries (three
per cent).

JPM Emerging Markets
One of two JPMorgan funds to feature in the current Leaders list, JPM Emerging Markets has a global emerging market remit. Launched in 1994 and managed for the whole of that time by Austin Forey, it is currently £409 million in size. The fund frequently invests via specialist closed-ended investment funds and uses fixed-interest securities. Its portfolio currently has 17.4 per cent in Brazil, 13.8 per cent in China, 12.5 per cent in South Africa and 12.2 per cent in India, with the heaviest sector weightings to Financials (23 per cent) and telecoms services (17.2 per cent).

AXA Framlington Emerging Markets
Launched at the beginning of 1993, AXA Framlington Emerging markets is currently £169 million in size. Its manager, William Calvert, has been part of the team running the fund for over ten years, assuming lead responsibility in 2004. It is another broadly based fund, frequently investing indirectly via companies operating in, but not necessarily based in, emerging markets. It has a very broadly based portfolio, with no individual holding representing more than two per cent. More than 53 per cent is currently invested in countries in the Asia Pacific region, with the major sector weighting, nearly 27 per cent, to financials.

Martin Currie Emerging Markets
One of the smaller trusts in the sector, at £49 million, Martin Currie Emerging markets was launched in 1991 and has been managed since march 2004 by Dariusz Sliwinski. The fund has a very broad brief, which allows it to make maximum use of the 20 per cent that can be invested outside the emerging markets universe – 4.6 per cent is currently in cash. However, its equity portfolio is based on the familiar areas of Brazil (15.7 per cent), China (13.8 per cent ) and Korea (12.5 per cent). Largest sector weightings are Financials (19.4 per cent ) and telecoms services (16.4 per cent).

JPM New Europe
One of the more specialist funds in the sector, JPM New Europe, concentrates on the emerging economies of Central and Eastern Europe. It has been managed by Amr Seif since August 2006. Launched in 1997 and £161 million in size, the fund runs a relatively concentrated portfolio, which inevitably has a heavy weighting towards Russia (just over nine per cent of its portfolio is invested in JPMorgan’s Russian Securities fund) and mining related stocks (its largest holding is MMC Norlisk Nickel). However, its highest sector weighting is to financials (33 per cent), followed by Materials (23.5 per cent).