What are the risks facing emerging markets this year? And will investors who venture in be rewarded? We reveal the funds to add to your portfolio

After a strong 2017, emerging markets are on course for further gains in the coming 12 months and beyond, but, as ever, it’s going to be a bumpy ride, warn analysts.

The MSCI Emerging Markets index returned 37.28 per cent in 2017--its best performance since 2009--to add to its 11.19 per cent gain in 2016.

This performance was driven by improving global and regional economies, resilient industrial data in China, continued earnings upgrades for Asian equities and a weak US dollar, says Min Feng, senior investment specialist at Nomura.

But emerging market equities still appear cheap relative to history and other regions. That’s because they are currently recovering from a low base. The commodity price slump between 2013 and 2015 meant the index saw negative returns three years running.

Now, Russ Mould, investment director at AJ Bell, notes that emerging markets overall are trading at around 1.7 times on a price/book basis, compared with cyclical peaks north of three times.

Still, investing in emerging markets is not for the faint hearted and should only be done with a long-term time frame in mind.

20 elections in 2018


“Although the current situation is about as calm as emerging markets get, a shock from the developed world would be felt in emerging markets as well,” says Hermes’ Gary Greenberg.

External events such as faster-than-expected US rate rises, North American Free Trade Agreement (NAFTA) talks, increased US protectionism, monetary policy normalisation by central banks and increased geo-political tensions pose risks.

As ever, politics will also weigh on emerging markets. There are elections in 20 different countries including Russia, Mexico and Brazil. While the result in Russia shouldn’t spring any surprises, Paul Greer, senior trading for emerging market debt at Fidelity, expects “heightened uncertainty and asset price volatility”.

Then there’s China, where a hard landing is still possible, though most economists do not expect this to happen.

China tech firms still attractive

Most are still positive on the region. Jan Dehn, head of research at Ashmore, isn’t worried about increased volatility going into elections. He says any extreme mispricing of assets will offer opportunities for investors to outperform the markets.

Tom Wilson, head of emerging market equities at Schroders, forecasts an aggregate growth rate of 4.9 per cent in 2018--in line with 2017.

A rebalancing in the make-up of the largest companies in the emerging market universe, from commodity-based firms to technology giants, should help with gains.

Jorry Rask Nøddekær, a portfolio manager with Northern European asset management firm, Nordea, sees attractive opportunities in Chinese internet and e-commerce names. Nøddekær and the Morningstar Investment Management team in the UK also likes South Korean and Taiwanese equities.

While no Australian-listed emerging market equity fund under the coverage of Morningstar currently holds a gold medal rating, there are three silver medal funds.

Aberdeen Emerging Opportunities

The Aberdeen Emerging Opportunities fund (11594) is an excellent fit for long-term focused investors, according to Morningstar analyst Mark Laidlaw.

"Aberdeen applies a consistent approach across all equity strategies, and the keys are quality and valuation.

"Other important traits include sustainable business models with high returns on assets and capital, as well as strong balance sheets," he says.

Laidlaw notes the portfolio management team has in the past faced criticism for not being critical enough of companies it covers. "Aberdeen has attempted to address this by taking a detailed look at some long-term positions that have stumbled, to determine whether the cause was structural or cyclical," he says.

The fund's capacity is another challenge of Aberdeen's strategy, "but over the long term, performance remains impressive".

Lazard Emerging Opportunities

Lazard Emerging Markets (4870) is another favourite of Morningstar analysts, with "high-calibre investors and a strict adherence to process," according to Andrew Miles, Morningstar manager research analyst.

"The process here is typical of Lazard’s robust approach, focusing on firms with improving fundamentals that haven’t been fully recognised by the market," Miles says

He also likes the Lazard team's consideration of top-down risk, which are "factored in to the intrinsic value, increasing the margin of safety, which should help sidestep the more speculative fare".

Stewart Investors Global Emerging Markets

The Stewart Investors Global Emerging Markets Leaders (17803), another silver medallist, is also a strong offering, despite some change to the business and its staff in recent years.

"Our view is that the resources across Stewart Investors are sufficient to cover its high-quality universe of stocks, and experience levels are still good with a number of highly experienced individuals on the team," says Morningstar analyst Michael Malseed.

"This vehicle retains the same approach that has served investors commendably over time…The approach has shown success over time and despite the changes, we retain a positive view of the fund."

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