Lonsec releases its 2014 Global Emerging Markets and Regional Equities Sector Review.

Lonsec yesterday released its 2014 Global Emerging Markets and Regional Equities Sector Review, highlighting a challenging year for emerging market investors in 2013 with ongoing concerns about the impact of  ‘tapering’ by the US Federal Reserve; and slowing growth and/or current account deficits in the ‘Fragile Five’ markets of Brazil, India, Indonesia, South Africa and Turkey.

In spite of this, the emerging market benchmark performed creditably during 2013, rising by 13%, with returns in AUD terms boosted further by the slight slippage in the currency. However, this was well below returns delivered by domestic and global (developed) equity markets – and in USD terms represented the poorest year of performance for emerging markets versus developed equities since 1998.

In terms of ratings, there were four rating upgrades and two downgrades among the 40 funds assessed. Five funds were assigned Lonsec’s premier ‘Highly Recommended’ rating.

“There was a large dispersion of performance among active emerging market managers over the year, with decision-making around holdings in the ‘Fragile Five’ economies having a particularly strong bearing on investor returns,” said Steven Sweeney, Senior Investment Analyst at Lonsec and principal author of the report. ”This highlights the importance of managers supplementing their bottom-up research process with a consideration of ‘top down’ or macro factors within the applicable investment process.”

Lonsec recommends that investors, and their advisers, use specialist emerging markets managers who have dedicated resourcing and tailored investment approaches as opposed to global equities managers who focus on traditional developed markets.

“Our higher rated managers will tend to be singularly focused on this asset class. They will have people on the ground in emerging markets and/or a substantial program of company visits, and will not see emerging markets as a bolt-on to other strategies,” Mr Sweeney said.

Lonsec also advocates active over passive investment strategies in emerging markets, although it recognises that there are a growing range of investment options for those seeking index exposure.

”Emerging Markets is an asset class where investors should afford managers greater freedom to add insight in portfolio construction, and pay fees for active management. Skilled emerging market managers really can add value through the decisions that they make,” Mr Sweeney concluded.

 Other key findings of the report include:

• Investment in Frontier Markets – developing, pre-EM economies like Nigeria, Pakistan and Vietnam – remains minor and generally non-existent.
• Asian equities – which makes up over 60% of the emerging markets benchmark – continued to outperform other significant economies in 2013 such as Brazil and Russia.
• For all the talk of the economic decoupling of EM economies from the influence of the US and the West, recent history confirms that EM performance remains hostage to US economic sentiment.
• BRIC economies continue to struggle to recapture the positive momentum of a decade ago with each contending with various economic flare-ups.
• Political risk remains a clear and present danger for emerging markets investors. Geopolitical events tend to dominate emerging markets, more so than in advanced economies. Weakening AUD boosts returns.
• The AUD has weakened over the past 18 months falling from $1.04 against the USD at the beginning of 2013 to US 0.89c at the end of the year. The majority of funds are unhedged which has aided performance for Australian investors.

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