Mar­ket myths

When you don’t want a tracker fund

The Daily Telegraph - Your Money - - FRONT PAGE -

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

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