Emerging market (EM) equities are not for the faint of heart. Investors can expect dramatic price movements in response to geopolitical events – and given more than half the global population is voting in elections this year, volatility is all but guaranteed. Add in continued US dollar strength (typically a headwind for EM economies) and managers in charge of generalist emerging market funds clearly have their work cut out, as do investors chasing returns across the asset class.
The diverging fortunes of China and India have been the focus of much attention in the post-pandemic era. Positive demographic trends and a resilient economy have turned the latter into a standout among the emerging market cohort. Meanwhile, China’s stuttering economic recovery, regulatory crackdowns and slide into deflation have done little to endear it to foreign investors. This does, however, mean that the country’s stocks look cheap. Whether they’re undervalued – especially in relation to high-performing peers in India – is up for debate.
“If Chinese equities are to return to favour convincingly, investors will need consistent and supportive policies, a stable regulatory environment, and a welcoming stance towards overseas investment in Chinese companies,” says Rob Morgan, chief investment analyst at Charles Stanley. “Suffice to say these things are not necessarily a given, which makes China higher risk and means a big discount to other markets is merited.”
With a market cap of more than £1.7bn, Templeton Emerging Markets Investment Trust (TEM) is the largest investment trust in the Association of Investment Companies’ global emerging markets group by some margin. Its current discount to net asset value (NAV) of 15 per cent also means it’s among the cheapest. In this context, it's perhaps unsurprising the fund is heavily weighted towards China, although it offloaded some of these holdings in its last financial year.
Portfolio manager Chetan Sehgal notes most of the fund’s remaining China exposure is in internet-related sectors “where companies continue to generate cash and have elevated shareholder return policies”.
As of 31 March, it retained £490mn in stocks listed in China or Hong Kong – representing around 25 per cent of its total investments. This is a significant downgrade from the £616mn on its books at the close of FY2023.
However, trusts with greater India exposure haven’t always performed much better, either.
JP Morgan Emerging Markets (JMG) – which has 24 per cent of assets in India and just under 19 per cent in China – currently trades at a 13 per cent discount and has delivered a NAV total return of 3 per cent in the past year. In this case, the manager has placed blame with individual stocks (as opposed to fundamental issues with geographic allocation). In the six months to the end of last year, some of its largest Indian investments were exporters of IT services, which struggled in a sluggish macroeconomic environment.
The problem, in other words, was not with the domestic market, but with international demand. Ashoka WhiteOak Emerging Markets Trust (AWEM) is similarly overweight in Indian equities, but it has managed to deliver a NAV total return of 12 per cent in the past year – one of the highest in its peer group. Key contributors include a jewellery retailer and an art materials business, as well as a Mexico-based auto insurer.
The differing fortunes of EM funds can partly be put down to these individual stockpicking decisions. Geographic allocation is merely one factor that can explain returns (or a lack thereof). Among open-ended funds, GQG Partners Emerging Market Equity (IE00BDGV0K75) is the top performer in the Investment Association’s global emerging markets sector, having posted a return of almost 34 per cent in the past 12 months. Although the fund has a 30 per cent allocation to India, its single-largest holding is a favourite of many EM portfolios: Taiwan Semiconductor Manufacturing Company (TSMC) (TW:2330).
This is also the case for Artemis SmartGARP Global Emerging Markets Equity (GB00BW9HL249), which has risen 20 per cent in the past year despite a 30 per cent allocation to China. In fact, TSMC is the largest holding for most generalist EM investment trusts, too. That's little surprise given the MSCI Emerging Markets Index – the benchmark for many of these funds – is now nearly 9 per cent weighted towards the company.
Meanwhile, the relative representation of India versus China in the EM index is now the closest it has ever been – with weightings of 18 and 27 per cent, respectively. Bank of America Merrill Lynch’s May fund manager survey revealed that the average manager remains underweight China indicating sentiment towards the country remains subdued. But according to Darius McDermott, managing director at Chelsea Financial Services, the two countries are now best viewed as complementary to one another in a portfolio.
“India’s aggressive growth potential can act as a counterweight to any stagnation in China's maturing economy,” he says. “Conversely, China’s value proposition offers a hedge against downward corrections in India’s potentially overheated market.”
One such lurch happened earlier this month after Prime Minister Narendra Modi failed to secure an outright majority in the country’s general election. An exit poll had initially suggested the result would be a landslide for the incumbent party, sending the Nifty 50 stock index to a record high. A sharp sell-off followed when this failed to transpire, although the market had fully recovered only a few days later.
“The election surprise in many ways acted as a welcome reminder that India remains a democracy,” says Jason Hollands, managing director of Bestinvest.
An election, albeit not a domestic one, may also determine whether Chinese equities can decisively emerge from their bear market. If Donald Trump is elected in the US this November, a simmering trade war could potentially ignite. In the past week, EU lawmakers also told Beijing they plan to impose tariffs on imported electric vehicles, thereby increasing tensions on this side of the world.
“Major western firms are also diversifying their supply chains away from China, and India is one of the biggest beneficiaries of this trend,” Hollands adds. As this may imply, picking winners in emerging markets is a complicated task. So long as global supply chains remain deeply interconnected, success in one equity market will depend on successful trading relationships with others. Whether all this translates into continued growth for funds and trusts invested in the asset class is another question.
