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Spend & Save

Sing about the brics for a spot of Isa excitement

Rewards beckon amid the risks but investors should be sure to treat  the emerging markets with caution, advises Neasa McEarlean

With only two weeks to go until the end of the Isa season on 5 April, a lot of money is heading into the riskier end of the spectrum through emerging-markets funds. At least one big player, Chelsea Financial Services, believes twice as many people might opt for the sector this year, taking the total invested up from 5 to 10 per cent on its platform.

There are other signs that emerging markets have again caught the imagination of many more sophisticated investors this year. Aberdeen Asset Management, one of the two leading managers on emerging markets, is introducing a 2 per cent initial charge on its £3.7bn Aberdeen Emerging Markets Fund, the biggest unit trust in the sector, from 15 April. This has been taken “as a further step to reduce inflows” into the fund because, despite other measures taken to discourage excessive investment, Aberdeen is concerned it could receive more new money from enthusiastic investors than it can sensibly handle.

Another sign of renewed investor interest is that, in a time when there are very few launches, two new funds have been opened recently in the emerging-markets sector. The Matthews China Dividend Fund was launched in January, on the heels of the Emerging Income Fund from Newton.

For those who want to invest in the  Bric countries – Brazil, Russia, India and China – and others which are still developing, there are two big names.  “Aberdeen Asset Management and First State have dominated the market over the last two decades,” says Adrian Lowcock, a senior investment manager at the Isa platform-provider Hargreaves Lansdown. “It isn’t easy to make money in emerging markets consistently but that’s what those two have done.”

Many other houses participate in the market. Newton, with its Asia Income Fund and the new Emerging Income Fund, is one of the leaders opening up the sector to specialist funds dedicated to paying an income.

“The development of income funds is a really significant sign that corporate governance is a lot stronger than it once was,” Mr Lowcock says. He thinks the potential for such funds in parts of the globe is marked. “The Asians are strong savers and quite cautious: they like having a dividend.”

Emerging markets are to be approached with caution, however, as their share values will tend to fluctuate more wildly than those of the more developed economies. Many investors had their fingers burnt when they followed star manager Anthony Bolton into his new Fidelity China Special Situations fund three years ago. Share prices lurched down to 70 per cent of their opening value as Mr Bolton learnt that some of the companies he had invested in had not been totally straight in reporting their results.

The track record of China Special Situations underlines the advice that emerging markets investments should be made for a minimum of a decade.

Currency fluctuations are another risk of investing overseas, especially in less stable regimes. The G20 agreement last month to avoid currency wars does not mean that the recent volatility is over. Keith Evins, the head of retail marketing at JP Morgan, says: “Quite often, the more general emerging markets funds will be hedging away currency risk. Some do, some don’t. It’s a sensible thing to do.”

To find out if they have clear powers to hedge, investors need to look at the objectives of the funds. For instance, the JP Morgan Africa Equity fund “may invest in assets denominated in any currency, and currency exposure may be hedged”.

People entering emerging markets for the first time are best advised to go for the large diversified global funds rather than going into narrow country funds. So they might, for instance, go for Aberdeen Emerging Markets or First State Global Emerging Markets.

Over the past five years, the First State fund has delivered total returns of 89 per cent – in part because the manager, Jonathan Asante, is empowered to take shelter in multinationals with an emerging markets bias during difficult times, rather than going deep into the countries themselves. Neptune Russia & Greater Russia, which has to invest “mainly in Russian and Greater Russian companies”, has fluctuated by as much as 60 per cent in market value in the past five years. Its total return in that period is just 3 per cent.

There is debate now as to whether Brazil, China and certain other countries often called “emerging markets” should still bear that label. China, for instance, where historically low wage costs are rising, is turning to some African states as low-cost suppliers to support the development of the Chinese middle class.

As these shifts occur, some investors who targeted emerging markets a decade ago are looking at “frontier markets” such as Vietnam and Bangladesh, which offer substantial growth opportunities but have yet to emerge as stable investment economies. Mr Lowcock recommends that individual investors put no more than “2 per cent tops” into this category.

Brazil is attracting more attention – not least because it is hosting the 2014 World Cup and 2016 Olympics, which could trigger higher growth and improved investment stability. The Allianz Brazil Fund was a top seller on the JP Morgan investment platform in 2012, and at the start of this year.  But a more cautious way of entering Brazil than going for a single-country option would be to invest in a fund such as the Aberdeen Latin American Equity Fund or First State Latin America.

Investors in emerging markets funds will often be described as “sophisticated” by financial advisers. This tends to mean they have a way of protecting themselves from the volatility and other risks of the sector. Wealthy people who have built up a good base in income funds and in the UK fall into this category, as they should be able to ride through years of volatility and could accept a loss of some, or even all, of their emerging-markets investment.

Another group are children who can invest long-term. Parents will not want to put that much of their offspring’s Junior ISA funds into the rougher end of emerging markets but they could put 5 per cent or so into the general emerging markets funds. Assuming that toddlers will not be needing the cash for 15 years or more, they are the investors who are potentially the most “sophisticated”. As Mr Evins says: “The younger you are, the more risk you are likely to tolerate.”

Case study: Monthly investments smooth out the bumps

Euan Grant has been investing in emerging markets since the 1980s.  “The performance has been positive,” he says. “Over the long term they have been pretty good and I’m fully satisfied.”

The former Customs officer started out with small lump-sum investments in unit trusts in the Pacific Rim, excluding Japan. “The growth, lack of debt and resilience of these countries was already becoming known,” he says.

Since then he has switched over mainly to making monthly investments. The smoothing effect of investing monthly keeps the volatility down and means he does not make a lump sum investment only to see it fall in value by 30 per cent, which can happen in these markets.

From his home in London, Mr Grant has held his equity investments on the platform offered by Chelsea Financial Services.

He has not invested directly in India but adds: “Some of my holdings – in Unilever and Vodafone, for instance – are proxies for India.” He is exposed to China through a Hong Kong fund.

He has largely stayed out of Latin America but is thinking of going into Brazil within the next six months. “Brazil is a good proxy for growing demand for food,” he says.

Although Mr Grant has seen some of his investments yo-yo at times, he is still committed to the emerging market sector for a portion of his Isa allowance.

What does he expect to earn? “A high single-digit total return is not unreasonable,” he says.