Emerging markets equity rush takes closed-end route
After the bottom, the deluge, as Victor Hugo might have said if he had been transported from 19th century French literature into 21st century British financial services.
Since the developing world started rocketing off its lows 12-18 months ago, British asset managers have been flocking to launch emerging market equity portfolios.
The twist this time is that many of these more adventurous launches have come in the more traditional investment trust arena, an invention more readily associated with the Victorian era than the hedge funds and absolute return vehicles of today.
”The closed-end structure enables you to go with confidence into names you might not go into where liquidity is a constraint”
The most famous of these newcomers remains Anthony Bolton’s Fidelity China Special Situations fund, which entered the FTSE 250 last week. However, within the past seven days Aberdeen Asset Management has also announced the launch of a Latin American Income investment trust, while JP Morgan Asset Management has come out with a listed Emerging Markets Income vehicle.
For fund managers, the chief advantage of an investment trust is its popularity among some of the private wealth managers, who tend to be more interested in specialist strategies than the broad retail market. For investors, the chief virtue of a closed-ended emerging markets fund is liquidity.
Emerging market investment trusts can invest in small and mid-cap stocks without worrying about having to sell them in time to meet redemptions.
As anyone who invested in New Star’s Heart of Africa fund will remember, open-ended funds that invest in illiquid emerging market stocks can end up being closed to redemptions and even sold on if the market is parched of trading. (article continues below)
As David Barron, the head of investment trusts at JP Morgan Asset Management, points out: “The closed-end structure enables you to go with confidence into names which you might not otherwise go into where liquidity is a constraint.
“You don’t have inflows or outflows diluting your best idea. If you have periods with big inflows and outflows, these are not costless for continuing shareholders.”
If the experts are to be believed, and local domestic consumption is the story of the next decade in emerging markets, investors will be looking more closely at less liquid, more locally focused smaller stocks for returns.
As the case of Heart of Africa illustrates, this could be extended to include frontier markets, although there have been few such launches as yet. Such notions hark back to the origins of the international investment trust as a convenient means for developed-world investors to gain exposure to new stockmarkets.
The impact of picking emerging market mid caps in particular can be phenomenal. Madhu Kela, the head of equity at Reliance Capital Asset Management, based in India, has earned a fund manager award from the country’s prime minister and a place in a list of “100 most influential Indians” by picking Indian mid caps and watching them grow to large caps.
Over long-term timeframes, he has massively outperformed the market.
There are also diversification benefits of small and mid-cap stocks which become obvious when one looks at the Brazilian or even the wider Latin American indices, which are overshadowed by two giant shares: Petrobras and Vale.
Latin American managers tend to get left behind by the index when these stocks outperform, and investing in high-beta or uncorrelated small and mid caps gives them an opportunity to catch up when times are good.
Dean Newman, the head of emerging markets at Invesco Perpetual, has even managed to employ this as a long-term strategy on his open-ended Latin American fund.
The group is considering launching a Latin American strategy in closed-end format.
”Not having to sell Brazilian steakhouses before time is an obvious advantage of the investment trust format”
Although investment trusts do allow for a larger concentration in individual securities than open-ended Ucits funds, not having to sell Brazilian steakhouses or some of Newman’s other past holdings before time is an obvious advantage of the investment trust format.
Leaving aside the considerations of individual markets, James Budden, the marketing director at Baillie Gifford, says the launch drive is still fundamentally connected with what he describes as the “secular shift of economic power from developed markets to emerging markets”. In more commonplace language, Budden says, “those places are where the money is”.
He concedes that providers may be too worried about liquidity - Impax Asset Management recently announced it was launching its new closed-end Asian Environmental Markets strategy in open-ended format, while Jupiter Asset Management raised open-ended money for its China Sustainable Growth fund after trying to launch it as an investment trust.
But in the more illiquid growth areas of emerging markets, Budden says not having to sell out to fund redemptions can only be a good thing, particularly if investors deliberately get in early to find the emerging plays of the future.
Even in its global equity Scottish Mortgage trust, Baillie Gifford has bought into smaller Chinese stocks aimed at domestic consumers, such as New Oriental Education, Belle, a shoe retailer, and Ctrip, China’s equivalent of Expedia.
However, amid all the excitement about liquidity, William Hemmings, the head of investment trusts at Aberdeen Asset Management, urges investors not to forget other advantages of the investment trust format.
These include greater transparency, the ability to gear and having a fixed rather than a fluctuating pool of assets from which to pay a dividend.
As emerging market managers launch income funds to diversify away from British uncertainties such as BP’s dividend, the latter could become an important point for the future.
Will Dale Nicholls do a better job than Anthony Bolton running the Fidelity China Special Situations trust?