The long-term case for emerging markets is easy to grasp – less mature economies with more youthful demographics have scope for greater economic growth as they develop.

There are also short-term tailwinds thanks to the dollar weakening (a key factor as many countries in the developing world have their debt denominated in dollars) and the Chinese economy fully reopening after Covid.

WHY YOU MIGHT WANT TO USE A FUND MANAGER TO GET EXPOSURE

However, investing in this space can be a rocky ride. The patchy start to the year for emerging markets – demonstrated by the underperformance of the MSCI Emerging Markets index versus its MSCI World counterpart – reflects their inherent volatility. It also speaks to the advantages of pursuing a more refined approach and tapping into the expertise of an active manager with stock picking skills rather than simply tracking a broad index.

There are more than 60 investment trusts and funds with emerging markets focus available to UK investors, all with their own individual approach to achieving returns.

The newest name is Ashoka White Oaks Emerging Markets (AWEM), which in April this year became the first investment trust to join the UK stock market in 16 months.

Against a difficult market backdrop the trust only raised £30 million against a targeted £100 million but former Goldman Sachs emerging markets expert Prashant Khemka, who set up parent asset manager WhiteOak Capital and who is running the fund, says this is not a problem and points out WhiteOak’s Ashoka India Equity (AIE) trust started with £46 million against a targeted £100 million five years ago and has now more than quadrupled that total at £200 million in assets.

The fee structure will see the investment adviser receive an ‘alpha fee’ paid in ordinary shares and based on the trust’s outperformance of the MSCI Emerging Markets Net Total Return index (in sterling) over discrete three-year periods.

As we write Ashoka White Oaks Emerging Markets has yet to publish a factsheet on its portfolio and when Shares spoke to Khemka in May, his team were still in the process of using the money raised from the stock market flotation to invest in stocks.

He says: ‘Now is not a bad time to be investing in emerging markets. The fundamentals are stronger than the developed world, with less recession risk, lower debt, lower levels of inflation and valuations are at the low end of the range.’

He points out that emerging market financial stocks are on a ‘much stronger footing’ than in the developed world and argues that because emerging markets are less efficient a good fund manager in this space has a greater chance of delivering outperformance than a similarly skilled manager in developed markets.

FOCUS ON CORPORATE GOVERNANCE

Ashoka’s investment strategy has a big focus on corporate governance but Khemka is keen to stress that governance issues are not restricted to the developing world. ‘The most insightful lessons I learned on corporate governance came in the US – the human instinct to cheat and swindle can be found anywhere.’

He acknowledges these issues ‘manifest’ themselves differently in emerging markets. ‘The dispersion is greater,’ he says. ‘Some companies have the finest of governance so they can serve as a benchmark even to Western companies but something like half the market is below the  average level.’

Khemka observes that a much greater proportion of emerging markets are in state ownership which by design is not helpful to minority shareholders.

For this reason, while state-owned enterprises constitute 18% of the benchmark, they represented 1% of the model portfolio used to market the Ashoka trust. Another important component to the trust’s approach is to avoid investing in undemocratic countries. Think of it as democracies versus despotic regimes, rather than simply developed versus emerging markets.

Khemka notes that property rights of minority shareholders are better protected in countries where you have a separation of power between government and the legal system. He says China is the only democratically deficient jurisdiction where the trust will have exposure.

A MORE ESTABLISHED INVESTMENT TRUST

Mobius Investment Trust (MMIT) is a slightly more established emerging markets vehicle and has legendary emerging markets investor Mark Mobius at the helm. Launched in late 2018, over the last three years it has outperformed the wider AIC Global Emerging Markets category with respective share price total returns of more than 65% versus 16% from the benchmark. This outperformance does come at a cost with ongoing charges of 1.5%.

Co-manager Carlos Hardenberg tells Shares he has ‘developed an intolerance of the phrase “emerging markets investing”’.

Hardenberg explains the approach pursued at Mobius has little to do with investing in the benchmark but instead about tapping into a large universe of innovative and entrepreneurial companies.

DISCOUNTED VALUATIONS

‘I find it exciting we’re in an environment where the world is focusing on tension between China and the US, inflation, interest rates and the war in Ukraine and that has helped lead to a discount in book values in emerging markets of more than 70% compared with the S&P 500,’ he says. ‘I don’t think there’s ever been a discount that great.’

Hardenberg adds that the fund considers both corporate and public governance or, in other words, the way companies are run at the micro level but also the environment in the relevant geography. He notes that the Mobius trust was not invested in Russia, for example, even before the country’s invasion of Ukraine.

He acknowledges culture is a tricky thing to define but is nonetheless important. He cites top holding, Indian technology services firm Persistent Systems (PERSISTENT:NSE), as a company whose entrepreneurial founder has done an excellent job of allowing the workforce to participate in its success and thereby helping it to retain talent.

‘A slightly nasty way of finding out about the inner dealings of a business is to look at local social media,’ he says, citing rating sites in emerging markets which are comparable to Glassdoor in the US and UK.

Hardenberg says he is excited by Asia. ‘It produces fabulous businesses, there’s fantastic depth, there’s a nearly infinite pool of talent and a huge opportunity to innovate and export globally. It’s a real cradle of ideas, eight out of 10 research hours are spent on Asian companies.’

Within that and, notwithstanding the geopolitical risks created by China’s designs on the territory, Hardenberg is enthused about the potential in Taiwan.

By contrast, the trust avoids investing in areas like fossil fuels, pornography, weapons and does not invest in banks. These exclusions help create a significant bias towards technology in the portfolio, with the sector having a weighting of nearly 60%. 

A MORE BALANCED APPROACH

A fund with a slightly more balanced approach is Polar Capital Emerging Market Stars (BFMFDG4). Steered by Jorry Nøddekær since its launch just a few months before the Mobius trust, the manager pursued a similar strategy at previous employer Nordea Asset Management. The Polar Capital fund has an ongoing charge of 0.87%.

Around half of the portfolio is in large emerging market firms – with widely held names like Taiwan Semiconductor Manufacturing Company (2330:TPE) and Samsung Electronics (005930:KRX) among the top 10 holdings. The other 50% is in small and mid-cap firms.

Nøddekær says: ‘Yes, 95% of my emerging markets peers will own TSMC but their holding will likely be very close to the benchmark level whereas we are 280 basis points overweight and similarly with Samsung we are 250 basis points overweight.’

He adds: ‘When we look at the small and mid-caps, they feel very differentiated, very few competitors will own names like Indian retail mall developer Phoenix Mills (PHOENIXLTD:NSE) and South African resources firm Ivanhoe Mines (IVN:TSE).’

While the fund has a highly structured framework for examining valuation and corporate governance issues, there is flexibility too.

‘We’re quite willing to go with a visionary founder and relatively happy for them to have de facto control over the board as long as their wealth is aligned on the equity side,’ Nøddekær says.

He clarifies to say there is an exception where the founder has multiple businesses and it’s not clear where their commitment lies.

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