Occasionally, the global mutual fund industry produces a fund manager whose name becomes familiar even to those outside its usual orbit. One of these doyens, Franklin Templeton’s emerging markets (EM) pioneer, Dr. Mark Mobius, is set to retire after an esteemed 30 year career.
EM fund launches have been considerable
To put the durability of Dr. Mobius into perspective – when we go back to the late 1980s, there were only ten funds in what is now the broad-based Thomson Reuters Lipper Global Emerging Market Equity Funds classification. Today, there are some 1,200 funds in this classification, and in 2017 alone, we saw over 70 new fund launches.
The extent to which the broad EM church in equities has widened is reflected also by the growth in country and regional classifications: Asia, Europe, and Latin America all have their own separate EM classifications. Furthermore, there are 26 separate country fund classifications for countries from Morocco to Thailand, containing funds that could potentially contain a high proportion of EM shares.
Exhibit 1. AUM of Lipper Global Emerging Market Equity Classification (in U$ bn)
Lipper assets under management data go back to 2003. For that year global EM equities funds contained around U$115 billion AUM. Today, that total is just over U$1 trillion, which represents an average annual AUM growth rate of some 25% a year.
However, this has been anything but a neat compounding. In 2008 EM equity AUM contracted by 60%, and more recently, with the tapering of quantitative easing in 2015, some 20%.
Exhibit 2. Comparative 30-year performance of Lipper Global Equity Classifications (in U$ to December 31, 2017)
Performance and EM re-structuring
For the 30 years ended December 31, 2017, EM equity compounded at 8.8% pa (in U.S. dollars) in contrast to global equity ex-U.S. (6.5% pa), but it still falls short of global equity U.S. (9.1% pa). This was largely due to the magnitude of the global financial crisis drawdown, which affected EM equities over U.S. equities by a magnitude of 2x.
The evolution in EM equities isn’t just reflected in regional development and its infiltration into investor consciousness. As Dr. Mobius himself points out, the composition of EM markets has shifted dramatically over the last ten years. The proportion of “traditional” EM sectors such as energy and materials stocks have decreased materially with a commensurate increase in technology and consumer exposure.
Liquidity risks & passive flows
However, liquidity and volatility are key risks that, despite structural changes, remain. Gary Greenberg, manager of the U$3.4 billion Hermes Emerging Market Equities Fund, points out that of the 30,000 EM stocks he considers his investible universe, there are fewer than 3,000 of sufficient liquidity to include in a modest-sized EM equities portfolio.
Compounding this issue further is the effect of passive vehicle concentration. Approximately 33% of fund assets (at the end of 2017) in the Lipper Global EM Equities classification are held in passive vehicles. By comparison, the equivalent figure for all funds registered for sale in Europe is 18%. Any late-cycle rotation out of passive vehicles into active funds could certainly affect EM markets disproportionately.
By way of example, the most recent Eikon Fund Share Holders Report for Tencent (the largest holding in the iShares MSCI Emerging Market ETF) reveals that of the ten largest fund share holders for this stock, eight are passive or low tracking-error vehicles.
Source: Thomson Reuters Lipper, Lipper for Investment Management.
Volatility remains above other equities
Despite the possible headwinds of increasing interest rates and an appreciation of the U.S. dollar, the EM story remains compelling for many investors. The contribution of EM countries to global GDP growth is material, and market valuations are relatively attractive.
However, despite the myriad changes seen in EM during the time of Dr Mobius’s career, there hasn’t been a commensurate decrease in volatility of EM equities over that of other regions. The average of the five-year volatility in EM equities since 1987 (rolling quarterly in USD) is 46% higher than that of U.S. equities and 32% higher than that of global equities (ex-U.S.).
It remain to be seen what progress is made on this front over the next 30 years.
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