If new fund launches at the end of 2011 and early 2012 were any indication, the smart money is choosing to plunge into emerging markets-foreign currencies and all-armed with new strategies.
Practically every large fund operator or starched-collar firm has either launched a fund in a growing economy somewhere or is planning to: BlackRock, Pimco, Alliance Bernstein, Investec, Fidelity, T. Rowe Price, Aberdeen Asset Management, Lazard ... the list goes on. And this time many are avoiding being boxed in by styles and sectors. The favored vehicle is an emerging market fund holding multiple asset classes-bonds, equities, currencies, commodities-piloted by seasoned managers who, aided by technology, can adopt strategies fast enough to hold course despite the dizzying volatility of our new lockstep global economy.
"Advisors in the U.S. obviously need to educate themselves about what's going on in the rest of the world," says Dawn Bennett, advisor for the Washington, D.C.-based Bennett Group of Funds. "Otherwise, they're just treading water." Bennett holds court weekly on radio and the Internet at http://www.bennettgroupfinancial.com. Her four funds (the BFAAX Bennett Aggressive Growth fund, the BFNAX Bennett Conservative portfolio, the BFOAX Bennett Growth fund and the BFMAX Bennett Moderate fund), are offered to advisors through Charles Schwab and Pershing LLC.
In addition to fund styles, the geography of the emerging markets is also changing. Bennett, who grew up in Asia, likes the "CIVETS"-Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa. These countries, she suspects, should outperform the BRIC nations of Brazil, Russia, India and China. And she expects both groups to do better than U.S. markets this year.
Another up-and-coming group, favored by fund manager Robert W. Scharar, is pan-African: Egypt, Kenya, Ghana and Nigeria. Scharar, president of FCA Corp., a Houston-based fee-only financial planning firm, launched the Africa Fund (CAFRX) in November. With more than 50 holdings in foreign companies doing business in these nations, the fund returned 4.99% from its inception on November 7 through January 27. The fund's expenses may look steep to investors. The net expense ratio in the prospectus is 3.02%.
People tend to think of Africa as one amorphous market, but it is actually made up of very distinct economies and cultures, says Scharar, who runs four funds for the Commonwealth Funds, mainly in developed or developing countries. "I believe strongly in diversifying not just among assets but economies and locales."
Scharar has done business in Africa for decades. A number of years back, he says, he invested in a shopping center in Malawi, which shares borders with Mozambique and Zimbabwe. He was delighted when a South African supermarket operator put a store there. Now it is a huge success, he says, "with sprayers over produce and a deli counter that serves local products as well as things we would know about, like Tobasco sauce from New Orleans. I always get a kick out of that." A strong sign of the continent's changing business climate, says Scharar, is Walmart's recent buyout of Massmart, a South African retailer with nine wholesale and retail chains with 288 stores in 14 African countries, for 16.5 billion rand ($2 billion).
Investors interested in East Africa have access through the new Nile Pan Africa Fund (NAFAX) offered by Nile Capital Management in New York. This equity fund gained 22.07% in its first year, outperforming the MSCI Frontier Markets index for the year ended April 2011. During the one year, the Frontier Markets index gained 9.94%, the Dow Jones Africa 50 Titans Index increased 11.07% and the S&P 500 Total Return Index advanced 16.67% annualized, according to the site Money Watch Africa.
According to these managers, the risks in emerging markets can be high, but they offer one of the few means of investment growth. Allan Conway, head of Emerging Market Equities for Schroders, told Morningstar, "Emerging markets today are the low-risk investment."
He meant it. "The weaknesses are in the developing world now, not emerging markets," Conway said in an interview with Financial Advisor. He says these countries aren't saddled with all the problems that developed countries have had since the financial crisis. He expects emerging markets to deliver real GDP of at least 4.5% this year.
In Schroders' SEMVX global emerging markets equity fund, Conway and his team are overweight in China, South Korea and Thailand and underweight in Mexico, India and Taiwan. The fund is neutral in Latin America and Brazil. He is also overweight in most of Russia, but underweight in Eastern Europe and South Africa. The fund also has holdings in Asia, Hungary, the Czech Republic, Poland, Egypt and Turkey. SEMVX was down 16.75% for one year but up 2.61% when averaged for five years. The fund's best year, 2009, ended with a gain of 76.86%. In 2008, it was down 51%. Definitely not for the faint of heart.
Because of the euro's woes, some managers are opting for debt funds denominated in local currencies. "It's a newer asset class," says Kristin Ceva, a managing principal at Payden & Rygel, and a manager on its Payden Emerging Markets Local Bond Fund (PYELX), launched in November 2011. "Some clients wanted 100% local currency," says Ceva, who also directs the firm's global sovereign debt strategies. "They wanted to diversify away from [the] dollar or other currencies." Ceva finds it improves inflows. "Investment flows tend to support currencies of those countries," she says.
One of Van Eck's Market Vector funds, the emerging market local currency bond fund (EMLC), also diversifies away from the U.S. dollar. With 72% of the fund in government bonds, 15.56% in corporates and 5% in government-sponsored development banks, EMLC strives to improve on the returns of the emerging markets global core index of the J.P. Morgan Government Bond Index, says Edward Lopez, Van Eck's market director for ETFs. In just over a year, the fund has acquired $26 million in assets under management. Its largest competitor is WisdomTree's emerging markets local debt fund (ELD), an actively managed ETF launched in August 2010 (a month after Van Eck's EMLC) that has a similar one-year return: 5.72% versus the EMLC fund's 5.76%. Lopez is also responsible for rebalancing the Van Eck ETF, whose 0.48% expense ratio is slightly lower than WisdomTree's 0.55%. ELD is more heavily weighted in Russia, Chile and Brazil. The EMLC fund's largest weightings are in Chile, South Africa, Russia and Malaysia.
The first half of 2010 saw declines in some local currency bond funds, recalls Lopez. "Some active managers were out. You have to know when to get back in." Van Eck maintained its index positions. When the managers rebalanced the portfolio to optimize the index, they were able to pick up bonds cheap, says Lopez, adding, "In some cases, [the] passive strategy affords the ability to get back in there faster."
Van Eck also has an equity emerging market fund (GBFAX) that benchmarks the MSCI-EM Index. "We like to follow domestic demand, which has seen rapid growth from consumers and service-based industries," says David Semple, the firm's director of international investment. Semple has noted more quality product output in the emerging market thanks to automation. There is also more stability in these countries' democracies, he says. According to Semple, the fund has benefited from the hard asset research the firm does for its Global Hard Assets Fund (GHAAX), which invests in energy, precious and base metals, timber and agriculture. "We feel more comfortable investing, in collaboration with our colleagues, where there's a significant natural resource-based advantage," such as in Africa, Kazakhstan and Argentina, he says.
In the case of BlackRock, the world's largest asset manager, diversification takes on a whole new meaning. Jeff Shen, the portfolio manager for the groundbreaking BlackRock Emerging Markets Long/Short Equity Fund (BLSAX), says his is the first emerging market hedge fund holding both long and short equity positions that is offered to retail clients. It's also unique in that it holds 600 names. "We take diversifying seriously," Shen says, "[with] many small bets across many names. Investors today need to take a far more 'granular' approach to the sector than they have in the past. We don't swing for the fences on a few names and hope it works out."
He's also very cognizant of managing risk. "Emerging markets can rise and drop 10% in a few weeks," he notes. BlackRock's massive holdings have enabled it to acquire vast data stores on market activity and securities. Add to this its stable of number-crunching quants. "We have a very robust risk model," he says.
For Shen's new fund, all 600 securities are put through the Sharpe ratio-adjusted, proprietary BlackRock risk model and aggregated through the portfolio to reach a risk number. Shen tries for a risk target of an 8%-15% overall fund volatility.
The firm is trying to do things differently from other people, says Shen, by focusing on individual, fundamental securities data. "You delve into infrastructure and resources. The process itself requires BlackRock's benefits of scale to cover 22-plus emerging markets," he says. It's important to be able to short in emerging markets, he adds, but difficult sometimes to borrow stocks. "Working with some of the largest counterparties in the world requires technology and numerous counterparty relationships," he says, and a separate dedicated team manages counterparty risk at BlackRock.
Standard & Poor's has created a subscription platform, called MarketScope Advisor, to rank emerging market funds according to risk factors, expense ratios and turnover rates. According to Todd Rosenbluth, a funds analyst at S&P Capital IQ, its recent top picks include the Calamos Evolving World Growth Fund (CNWGX); the T. Rowe Price International Emerging Markets Bond Fund (PREMX); Fidelity's New Markets Income Fund (FNMIX); and the Driehaus Emerging Markets Growth Fund (DREGX). These funds were chosen, says Rosenbluth, for how rich the rewards were for the funds' risks. (Financial advisors can access the data on a two-week free trial at www.getmarketscope.com.)
Another approach to emerging markets is to open funds to multiple assets and invest in anything-bonds, currencies, commodities, stocks, etc., a strategy that offers broader frontiers. Managers choosing the multi-asset style have greater flexibility in market turmoil such as currency or commodity turns.
One manager taking this mixed-asset approach is John Carlson, the lead manager on the Fidelity Total EM Fund, FTEMX, a bond and equities portfolio launched on November 1, 2011. If beginnings can be believed, the fund looks promising (it has had an 8.13% return since inception through January 27, 2012). Carlson's strategy is spelled out in his 1998 paper, "The Relationship Between Bonds and Stocks in Emerging Countries."
Still, advisors like Harold Evensky, of Evensky & Katz LLC, have watched so many investment cycles blow through and leave theories in tatters, that he says it's hard now to work up a sweat over something new. He likes passively managed emerging market funds, but also likes the actively managed Matthews Pacific Tiger Fund (MAPTX), part of the Matthews Asia Funds family, which has a nice 14.7% ten-year average. And he's somewhat impressed by Cap IQ's Driehaus pick, which had the 11th best Sharpe ratio. Then again, the index oracle John Bogle, in his book Common Sense on Mutual Funds, has compared the hallowed measure of downside risk, the Sharpe ratio, to a "blunt instrument." One thing that is certain: This generation's emerging market investor will have more knowledge to work with than any before it.