Should investors buck the ‘bottom up consensus’ in emerging markets?


Emerging markets go right or wrong at the country level and investors should buck the “bottom up consensus” in the asset class, says JO Hambro manager James Syme, but fund selectors say both approaches have their place.

Speaking at the Morningstar Investment Conference in London last week, Syme said the overwhelming bulk of money in emerging markets is run bottom up and a poll of the audience, made up primarily of advisers, found 65 per cent would choose this approach for emerging market funds.

But he argues managers should be taking a country driven approach to emerging markets, arguing the asset class is one of booms, crises and recoveries.

“Top-down considerations are vital. You don’t try and buy a good house in a bad neighbourhood. If an emerging market country is running into trouble or its overvalued or if the economy’s overheating, it’s not about buying the best stock there, it’s simply about getting out.”

The JOHCM Global Emerging Markets Opportunities fund has returned 48 per cent over the last year compared to 41.6 per cent in the IA Global Emerging Markets sector, FE data shows.

Over three years it has returned 45.8 per cent compared to 35.8 per cent in the index.

Syme says he invests in eight to 10 of the 23 markets in the index at any one time, saying India and Korea currently look favourable to him, while Turkey is the market “most likely to undergo some sort of catastrophic failure”.

“Although Turkey may look very cheap, we do have to remember some emerging markets don’t work out. Venezuela didn’t, Zimbabwe was even in the market when I started out. If one of the current markets is going to fail it’s going to be Turkey.”

South Korea is currently the second largest geographic allocation at 20.8 per cent behind 21.5 per cent allocated to China. Taiwan comes in third at 18.5 per cent, followed by India with 17 per cent.

Syme warns the bottom up consensus “first ignores and then overreacts to top down drivers”.

Speaking on his journey to becoming a top-down investor, Syme says the first stock note he ever wrote was on Mexican bank Grupo Financiero Bancomer, which he put a $24 target on in October 1994 as it sat at $22.

“On the 15th of December, Mexico defaulted on its sovereign debt and massively devalued its currency. Three months later Bancomer was at $1 and on its way to zero. That was my introduction to macroeconomic risk in emerging markets.”

Academic research shows over the long term emerging market GDP correlates with market returns, Syme says.

“If you had known in 2002 that the fastest growing emerging markets were going to be India, the Philippines, Brazil and even China, you would have done much better than buying the index or buying much slower growing country indexes, like Portugal or Taiwan.”

‘More than one way to skin a cat’

Tilney Group managing director Jason Hollands argues most emerging markets on their buy-list are bottom-up stock pickers, including Fidelity Emerging Markets and Somerset Emerging Markets Dividend Growth.

Hollands argues there’s “more than one way to skin a cat”.

“What we do like is funds which are index-unconstrained rather than compelled to allocate a proportion of the fund in a particular market just because in the index.”

AJ Bell head of fund selection Ryan Hughes also favours the Fidelity Emerging Markets fund, managed by Nick Price, which seeks companies with sustainable earnings growth and will invest away from the index “even when the macro looks awful”.

“This has been evidenced by specific stock exposure being maintained in Russia over the last few years when the macro picture has been very poor.”

Hughes adds: “For me it is not as simple as a binary choice between a top down and bottom up approach. Stock pickers who would consider themselves as bottom up will always be conscious of the macro environment that they are operating in and this will in part always have an influence on their decisions.”