Zenith Sector Review: Emerging Market fund managers endure short term pain as Asian IT sector hots up

Zenith’s Emerging Market Equities Sector Review has highlighted the dynamic tension that exists for fund managers between chasing performance and maintaining a strict investment discipline. Zenith’s rated fund managers generally underweighted the hot Asian IT sector – a move premised on maintaining their investment quality standards and benchmark-unaware style – to the detriment of short-term performance relative to the benchmark.

The MSCI Emerging Markets Index rallied 19.4% in the 12 months to 30 September 2017, and while this is an impressive result by any measure, it was predominantly driven by a handful of Asian technology and internet companies. The Emerging Markets IT sector returned 39%, double the return of the overall index for the same period. Despite generating strong absolute returns, the majority of actively managed Emerging Market equities funds rated Approved and above by Zenith underperformed the MSCI Emerging Markets Index over the last 12 months.

Thushani de Silva, Zenith Investment Analyst explained “While many IT companies in Asia have a dominant market position, they can be volatile with relatively opaque corporate governance and are potentially vulnerable to government or regulatory changes. Further, given the relatively elevated valuations of these IT names, they are potentially more susceptible to stock price corrections.“

Such concerns have led to substantial underweight positions to the IT sector across many fund manager portfolios rated by Zenith. The degree of underweighting was pronounced in portfolios that are not managed against the benchmark (benchmark unaware), and given that the IT sector now accounts for 25% of the total weight of the Index, these portfolios generally suffered more significantly in terms of overall performance.

Thushani advises that emerging markets needs to be considered over a long-term horizon. “For active managers, investing in Emerging Markets is not about chasing speculative gains confined to one sector of the market. Given the nature of these markets, a diversified stock picking approach that focuses on a range of fundamental drivers ensures that an optimal risk/reward is achieved over the long term.”

Summary of the Zenith 2017 International Shares Emerging Markets and Asian Equities Sector Review

From an initial universe of 46 products:

• 2 were rated “Highly Recommended”
• 17 were rated “Recommended”
• 1 was rated “Approved”
• 26 were “Not Rated”