Market myths

When you don’t want a tracker fund

Ideas for your portfolio

An alarming number of emerging market funds do no more than track their benchmark index, despite having access to far more companies than passive “tracker” funds that invest in the same region. Research carried out for Telegraph Money found that the majority of emerging markets funds with a 10year record returned less than the most prominent emerging markets index over the same period. The index contains less than 10pc of the companies available to active investors.

The conventional wisdom is that in the hard-to-analyse and often precarious conditions of emerging markets, active managers have more scope to outperform.

Developed markets are seen as more efficient, with greater availability of information, meaning that stocks are more likely to be priced correctly. This leaves less room for an active manager to spot undervalued opportunities.

In emerging markets, by contrast, there are far more unknowns and there is a much greater likelihood of shares being wrongly priced, giving active managers more scope for their analytical efforts to bear fruit.

For investors who seek high returns, emerging markets are hard to ignore. Despite recent setbacks, they tend to offer faster economic growth and are not encumbered by the Western world’s debt and demographic problems.

But making money consistently in emerging markets is difficult. Many find their performance tied to the fortunes of natural resources, whether as producers or consumers. But an abundance of resources is useless without good governance, while a global price crash can stop a dependent economy dead in its tracks.

Here, Telegraph Money weighs up the best way to gain exposure, and whether active managers justify their fees.

The numbers

The chart shows the 10-year performance of two of Britain’s top global emerging markets funds, Stewart Investors Global Emerging Markets Leaders and Aberdeen Emerging Markets.

The two funds are plotted against the MSCI Emerging Markets index, the average of the global emerging markets fund sector (which includes 83 funds) and the iShares MSCI Emerging Markets ETF, which tracks the index.

Ben Willis, head of research at wealth manager Whitechurch Securities, provided the analysis for the chart.

As would be expected, the two bestperforming active funds consistently outperform the other three, returning 258pc and 219pc respectively over 10 years. In both cases, this is more than double the returns of the index.

Although the fund sector average would be expected to be lower, it tracks almost identically the iShares index fund, barely deviating over 10 years.

In fact, of the 31 funds with a 10-year track record, only 10 outperformed the MSCI Emerging Markets index, according to FE Trustnet, the data firm.

Additionally, all 16 of the funds that returned less than the iShares tracker over 10 years have a higher ongoing charge figure.

Jamie Smith-Thompson, managing director of financial adviser Portafina, said active managers actually had an unfair advantage over the benchmark.

He said: “The benchmark is very limited and excludes huge parts of the market – particularly smaller companies, which is a huge growth area.”

This prompts two questions: first, do active managers justify their fees in the emerging markets sector; second, how can investors ensure they pick a top performer?

The value of active managers

Mr Willis said: “What is worrying is that the fund sector average is below par compared with the broader market. This means that there are plenty of active managers who are not cutting it.”

Managers’ fees in emerging markets tend to be high, up to 2pc. If you aren’t confident in your ability to pick a winning active fund, there is a strong case for buying an index tracker with a much smaller fee.

Picking the right horse

If you choose the active route, picking a winner is essential. One tactic is to look for funds whose managers are actually based in the region, which will allow them to meet far more companies.

Jeremy Le Sueur of 4 Shires Asset Management suggested that the fund sector average tracked the index so closely because of the presence of “closet trackers”.

He added: “Picking a good fund manager is hard. I would look at past performance, and possibly pick three of them per geographical region with consistently good returns over one, three and five years.”

Philippa Gee of Philippa Gee Wealth Management recommended holding no more than 6pc of your portfolio in the emerging markets sector, split equally between passive and active funds.

The conventional wisdom is that in the hard-to-analyse emerging markets, active managers have more scope to outperform