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The Lowdown On GEMs February 24, 2006
We compare and contrast various global emerging market equity funds.
Author : Bharathi Rajan

Untitled DocumentTHE LOWDOWN ON GEMS

Global Emerging Markets equity funds were very popular with Fundsupermart investors in 2005, and that trend appears to have continued into 2006. They have been among our top selling funds year-to-date. It's perhaps easy to see why. Global emerging markets equity funds invest in four main regions - Asia, Eastern Europe, Latin America and Middle East/Africa. These regions are among those with the highest growth rates in the world. To read more about emerging markets, click on the following articles (Uncovering GEMS, Uncovering GEMS: Emerging Europe, Uncovering GEMS: Latin America.)

According to Emerging Portfolio Fund Research - an emerging market research specialist and fund tracker, inflows into emerging markets equity funds reached their second best mark ever in the week ending January 18, 2006 despite a recent sell-off in global stock markets. The combined emerging markets equity funds tracked by EPFR attracted US$2.64 billion of net inflows during the week, less than the previous week's record of US$3.22 billion inflow, but it is still strong. In the first three weeks of this year these funds have received US$6.82 billion of net inflows, nearly one third of all of last year's record-setting inflows of US$20.3 billion. The strong investor sentiment in this asset class is strongly linked to performance. Emerging Market equities (as represented MSCI Emerging Market Index - the blue line below) have been rallying since the tail end of 2002. The breakdown of performance by region is also shown below.

While the emerging market universe as a whole has been performing well, the strongest performance has come Latin America and Emerging Europe, although Asia ex-Japan markets have also experienced strong rallies in the last 3 years. And although these markets are volatile, the annualised returns over longer periods (as shown in the fund performance table below) indicate that they can make a valuable contribution to a diversified investment portfolio (note that the returns of regional equity funds focused on Latin America, Eastern Europe or even BRIC - Brazil, Russia, India and China, would be significantly more volatile)



1 yr

2 yr

3 yr

4 yr

5 yr

10 yr

Since inception

Aberdeen Global Emerging Markets  








First State GEM Leaders  








Franklin Templeton F-Emerging Markets  








Schroder Emerging Markets








Source: Fundsupermart. The figures in the above table were last updated on 07 Feb 2006 with prices as of end Jan 2006. The performance figures in the table above are calculated using offer-to-bid prices, with any income or dividends reinvested. Performance figures of over 1 year are annualised. (Eg. A 33.1% gain in 3 years works out to a 10% gain per year when annualised.) As per MAS regulations, the offer price is based on the normal sales charge which is higher than Fundsupermart's discounted sales charge. The launch date for the Aberdeen Global Emerging Markets Fund is 8 August 2005.


The regional breakdown of the MSCI Emerging Market Index is shown below. It is a commonly used benchmark for many emerging market equity funds. When it comes to regional allocation, most emerging market equity funds with a relative return mandate, do not deviate too heavily from their benchmark index (refer to Uncovering GEMS: Emerging Europe, Uncovering GEMS: Latin America for a more detailed breakdown of the Eastern European and Latin American regional equity markets; and to the following articles for more on Asian markets: Make Way For Asian Laggards, Which Asian Markets Are Rated More Highly And Why

Middle East/Africa fall under the 'Others' category. Middle Eastern countries such as Saudi Arabia and Egypt have experienced a huge windfall from rising oil prices. As a result, their stock markets have literally boomed (in an August 2005 interview, Rupert Rucker, Schroder's Emerging market product manager, said that the Egyptian stock market had risen by as much as 400% in the preceding 3-4 years). However, many funds do not invest in the Middle East. They are unable to do so as these markets either have huge restrictions, or are off limits to foreign investment. In some cases, foreign investors are also prevented from repatriating profits to their home country. Most of these markets are also small and relatively illiquid (as measured by market capitalisation), with the exception of Saudi Arabia.

Funds that do invest in Africa, concentrate on South African equities. That equity market is the largest in the continent and has a market capitalisation of US$180 billion, bigger than Brazil's market capitalisation of US$120 billion, and three times larger than the market capitalisation for the Russian equity market. (See section on investment strategy and stock picks for funds to read about examples of South African stocks.)


The chart below shows the sector breakdown for the MSCI Emerging Markets Index. Once again, emerging market equity funds which are relative-return oriented, tend not to veer too far away from their benchmark index. As such, the chart below can be used as a yardstick for sector weightings for GEM equity funds. Commodity stocks tend to make up a a significant portion of GEM equity funds. Within the MSCI Emerging Markets Index, the energy and materials sectors make up about 27% of the index composition.


Commodity stocks are especially big players in countries like Brazil and Russia, which are among the largest and most liquid markets in Latin America and Emerging Europe respectively. Combined, these two regions make up over 30% of the MSCI Emerging Markets Index (see regional allocation). For example in Brazil, CVRD, and Petrobras are mining and oil giants respectively; CVRD (Companhia Vale do Rio Doce) is the world's largest global producer of iron ore and pellets, and the second largest global producer of manganese. Both materials are used to make steel, which in turn is used to build infrastructure. Petrobras or Petróleo Brasileiro S.A, on the other hand, is the largest company in Brazil. It operates in the exploration, production, refining, marketing, and transport of oil and its by-products, both domestically and overseas. It produces roughly 2 million barrels of oil per day. Together these companies make up about 24% of the MSCI Brazil Index. As for the Russian equity market, it has a market capitalisation of around US$60 billion and is dominated by oil and gas companies such as Gazprom and Lukoil. It also has a large mining company called Norilsk Nickel, which mines nickel, copper, cobalt, palladium, platinum and other precious metals (gold, silver), selenium, hard coal and other materials for industrial needs. It is the world’s largest producer of nickel and palladium and one of the largest producers of platinum. It also accounts for more than 3% of copper production worldwide. It is thus unsurprising that these names crop up among the top holdings of so many funds.

Fund managers interviewed by Fundsupermart indicated that commodity stocks will continue to feature prominently in GEM funds. Many believe that there is long term structural demand, especially from China. On the flipside, as supply is constrained, commodity prices are likely to stay high for an indefinite period of time. They also argue that despite their popularity with investors, resource companies such as Australian gold miner BHP Billiton (which reported a record 47% growth in profit of US$4.36 billion, for the six months to December 2005), have relatively attractive valuations. That's because their earnings are growing faster in relation to the price, thus keeping the PE multiple relatively low. Since company profits are fairly sensitive to commodity prices, soaring commodity prices and voracious demand from China, are helping resource companies to improve their earnings growth by leaps and bounds.

And while valuations are no longer as low as they were a few years back, they still make compelling investments, argue several fund managers. Thus, investing in emerging market equity funds will mean significant exposure to the commodity sector for investors, especially if they already have resource funds in their portfolios. While fund managers note the risks that come with investing in commodity companies, they mitigate that risk through quality control in the stock selection process, as well as diversification. Diversification includes investing in downstrean and upstream companies. Downstream refers to those companies that do not produce the resources, but support the industry, such as oil refineries and equipment suppliers. Upstream companies are typically the energy and mining companies. As for stock selection, fund managers that Fundsupermart spoke to said they had a preference for large well-run companies that could exploit economies of scale for profit. These are typically large companies that can keep down their production costs (drilling, exploration, pumping etc.), thereby maximizing their profit margin.


Next to resources, financial stocks typically make up the second largest allocation in many global emerging market funds and indices (they make up 20% of the sector allocation in the MSCI Emerging Markets Index above). According to fund managers we spoke to, this is a good way to play the consumer growth story in emerging markets. In an interview with the Fundsupermart magazine late last year, Liesbeth Rubinstein, a fund manager for the Schroder ISF Emerging Europe Fund said that financials was a particularly compelling theme for emerging markets, especially in Eastern Europe. “There is untapped potential in financials. You have a low level of consumer credit to GDP in these countries, and that means faster growth. A lot of these banks and financial institutions are regional franchises, and they are expanding beyond the immediate Eastern European countries to Serbia and Ukraine. This continues to support their growth, and they are still trading at discount valuations, relative to Western Europe. So you have a situation where my colleagues at the European equities desk, who cover Germany, France and the Euro-zone countries, actually come up to me and ask me about these companies. That’s how interesting they are, and how quickly they are growing relative to Western Europe.”


Fund managers have said that they are positive on emerging market equities in 2006, although they expect volatility to increase after the strong rally last year. They believe that while a pull back in markets is possible in the near term, the long term story for emerging markets is still very attractive. They cite the following drivers for growth:

  • Falling interest rate environment - this makes the cost of borrowing cheaper. Also, low interest rates are good for emerging market bonds, as they support the price of government bonds.
  • High commodity prices - Many emerging market countries are big producers of oil, gas, and miners of metals and minerals. They are feeding strong demand from countries such as China
  • Strong economic development and consumer growth - better economic growth, leads to growing income levels, and this in turn boosts consumer spending
  • Structural improvements for many emerging market economies - this includes improved levels of inflation, rising foreign reserves, lower debt levels, current account surpluses and better economic policies, and better credit ratings for government bonds
  • Relatively attractive valuations for Emerging Markets - emerging markets trade at a discount to developed markets, partly because of inherent political and economic risk; however fund managers argue that recent structural changes suggest that these markets should trade higher

At Fundsupermart, our research team maintains a positive outlook on Emerging Markets and has given the region a rating of 3.5 stars. (Click here to read an article on our star rating for regional markets; and here to read about our ratings for single country markets.) According to our research team, despite the sterling performance, the PE ratios for the Emerging Market region remain attractive. At 15.5X and 13.5X estimated PE for 2005 and 2006 (as at mid-February 2006), the Emerging Market region is one of the cheapest regional markets (see table below.)

Table showing PEs & Earnings Growth For Major Regions


PE YR 2005

PE YR 2006

PE Yr 2007

Earnings Growth 2006 (%)

Earnings Growth 2007 (%)

USA (S&P 500)






Europe (DJ Stoxx 50)






Japan (Nikkei 225)*






Emerging Markets (MSCI EM)






Source: (US data from Zack Investments; All earnings were updated on 30 Nov 2005; * Japan PE forecasts are based on fiscal year ended March 2006, 2007 and 2008 respectively)

However, in our star ratings methodology, we have given the market a score of 3.5 for valuations, lower than what we have given to Asia ex-Japan (which scores a 4.0). The reason is because of other considerations such as corporate governance, market openness and political stability. Some markets in Latin America and Emerging Europe are in the initial stages of opening up their equity markets and may present added risk in terms of corporate governance and market openness. Thus, we have discounted some of this potential risk from the overall score on valuations. We expect the average earnings growth to be reasonable in the range of 8-12% p.a. in 2006-2008.


Fund houses employ different strategies in managing GEM equity funds. These tend to be dependent on the fundamental investment style of the fund manager. Typically, most GEM equity funds do not deviate too heavily from the benchmark, even if there investment strategy is focused on picking stocks, and not making sector bets. However, they may vary in terms of individual country selection and choice of Top 10 holdings. On average the four emerging market funds invest in around 20 countries each. These include more familiar markets such as Brazil, Russia, India and China, right down to lower profile, smaller markets such as Croatia, Sri Lanka and Peru.

Aberdeen Global Emerging Markets Fund

The Aberdeen GEM equity fund (click here for the factsheet) adopts a team based generalist approach to ensure cross coverage of the region. Managers have little discretion to move from these models, and are not empowered to make decisions unilaterally. Among the fund's holdings are Femsa, a large Mexican beverage company, Aksigorta, a Turkish insurance company, and MassMart, a South African retailer. Massmart is a managed portfolio of 11 wholesale and retail chains, each focused on high volume, low margin, low cost distribution of mainly branded consumer goods for cash, in ten countries in sub-Saharan Africa. The Group is the third largest distributor of consumer goods in Africa, the leading retailer of general merchandise, liquor and home improvement equipment and supplies, and the leading wholesaler of basic foods. In an interview in the Fundsupermart magazine, fund manager Peter Hames cited this company as a good example of a high quality South African stock that was both profitable and innovative, with a great track record.

First State GEM Leaders

The First State's global emerging market equity fund (click here for the factsheet) adopts a team based approach, and its investment strategy is driven by a research process that uses quality, earnings and valuation filters to sift out stocks in the global emerging market equity universe. As at end December 2005, the fund had 4.4%, in AngloGold Ashanti (its second largest holding), a South African gold mining company. At 3% of the portfolio, the 7th largest holding was Grupo Modelo, a very large Mexican brewery that incidentally owns the popular Corona brand of beer. Familiar names such as Lukoil, Standard Chartered Bank, and Samsung Electronic also appear in the Top 10 holdings, although the fund appears to be slightly underweight the benchmark in the energy sector. It has 8.5% in energy stocks versus the MSCI's 14.3% in that sector.

Franklin Templeton Funds - Emerging Markets

Franklin Templeton's Emerging Market equity fund (click here for the factsheet) also follows a value oriented, stock picking approach. The fund invests in over 25 countries including Panama, Portugal, Czech Republic, and Croatia. The fund also has investments in Austria, Sweden, Finland and the United Kingdom, that are not typically associated with Emerging Markets. According to the fund house, this is because the fund manager has the leeway to invest in companies that have exposure to emerging markets, but are listed elsewhere. The lead manager for the fund is Dr Mark Mobius, a well-known speaker and author.

Schroder Emerging Markets Fund

Schroder's Emerging Market equity fund (click here for the factsheet) is supported by an investment team of 26 investment professionals covering various emerging markets. The team is led by Alan Conway, Head of Emerging Markets at Schroder Investment Management. The fund targets 80% value added from stock decisions and 20% from country decisions, and uses proprietary stock research database/models. The investment process relies on quantitative models to determine country allocation decisions. Risk controls include stop/loss rules, as well as alpha adjusted tracking error targets. The fund's top three country allocations as at end November 2005, are South Korea (22%), Taiwan (14%) and Brazil (11%), and combined they make up almost half the fund.


GEMs equity funds can be part of the core portfolio for the long term investor (click here to read about our core and supplementary portfolio). They are considered high risk (with a Fundsupermart risk rating of 9; click here to view our risk rating system) and can achieve relatively high returns. Although GEMs equity funds are diversified across sectors and markets, they are sill significantly more volatile than global equity or bond funds. That's why we encourage investors to diversify accordingly (click here to read an article on the importance of diversification).

The pie chart above illustrates where core funds belong in an overall portfolio. The percentage, which should be allocated to global bond funds, is dependent on an individual's risk profile. The diagram shows the asset allocation for an aggressive investor, and may not reflect an individual's risk/return profile. (To view investment portfolios tailored for different risk profiles, click here for our Fundsupermart Recommended portfolios).

This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund's prospectus. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer

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