Top performing EM fund managers readying for tough 2016

[LONDON] Mutual funds investing in Korean, Russian and Chinese equities led the emerging market pack last year, but weak growth and high levels of market volatility are set to test top performing fund managers in 2016.

Investors have already started dumping emerging assets in January, pushing stocks to 6-1/2-year lows, while another 20 per cent fall in oil is ramping up pressure on producers.

That presents a challenge after 2015's strong rebound in Moscow stocks, which helped Russian-focused equity managers earn double-digit returns. They filled three of the top 10 slots in a league table of fund performance based on data from Lipper.

"The key risk is related to the oil price," said Vladimir Tsuprov, chief investment officer of TKB Investment Partners, which advises the second-placed Parvest Equity Russia fund. A deeper oil price decline that weakens the rouble further could rule out interest rate cuts, he said.

Thomas Smith, deputy manager of the Neptune Russia & Greater Russia Fund, which was ninth in the league table, foresaw another contraction in Russia's economy and a budget deficit of 3 per cent of GDP or more.

In this difficult environment, Smith said non-traditional exporters such as technology stocks would be the winners. He attributed some of his fund's outperformance in 2015 to investments in email service Mail.ru and software developer Luxoft.

Tsuprov also said a position in Luxoft had paid off in 2015, as had investments in Nord Gold and oil producer Surgutneftegas, which benefited from falling costs on the back of a weaker rouble.

But with commodity prices tumbling, Tsuprov is also focusing on local demand-oriented companies such as mobile operator MTS , which offers a healthy dividend yield.

Similarly, investing in consumer stocks with a dominant local market share helped Invesco's Korean Equity fund to top the league table despite South Korea's deteriorating growth and falling exports, its manager Simon Jeong said.

Three Chinese equity funds survived a rollercoaster ride in 2015 to make the top 10. The bottom of the table was dominated by equity funds focused on Brazil, whose economy was hammered by a corruption scandal, a ballooning budget deficit and high inflation, and Latin American stocks more broadly.

The average performance for the Lipper Global EM equity fund sector as a whole was -9.5 per cent. Some $69.2 billion was pulled from EM equity funds globally in 2015, according to preliminary data from fund flows research house EPFR Global.

For bond investors, dodging bullets was just as important as participating in the year's big turnaround stories, chiefly Ukraine and Argentina. "Volatility is high, liquidity is poor and fund performance hasn't been good across the industry," said Richard House, manager of the second-placed Standard Life Investments Emerging Market Debt Fund.

The average performance for the Lipper Global EM bond fund sector was -5.7 per cent, with local currency funds losing the most. The JP Morgan local currency sovereign debt index fell over 15 per cent in 2015 whilst its hard currency sovereign and corporate debt benchmarks returned just over 1 per cent.

Some US$32.6 billion was pulled from EM bond funds globally in 2015, according to EPFR Global. "Local market funds have been an outflow asset class for a while, as performance has been poor and that experience is going to impact people's mindset going forward," House said.

Claudia Calich, manager of the first-placed M&G Emerging Markets Bond fund, said she outperformed by keeping local currency exposure to just 10 per cent and avoiding some of the credits hurt by falling commodity prices, such as Iraq.

She also managed to catch the rallies in Ukraine and Argentine debt. For 2016, she favours hard currency debt from central America and the Caribbean, where economies benefiting from overseas workers' remittances should do well from a stronger US labour market.

SLI's House added that in markets such as Brazil or Venezuela where prices were at extreme levels, significant asset price gains could follow political change. For instance, markets might see the impeachment of Brazilian President Dilma Rousseff as a positive for reforms, he said. "Even a period of stability would be good for emerging markets," House said. "The carry is becoming compelling, so even if you get stability you will make decent money in context of decent yields."

But Calich warned tail risks would remain elevated in 2016 following defaults in the Brazilian construction sector and pressure on some commodity-related credits. "We are still transitioning to an environment with lower commodity prices and higher financing costs," she said. "We haven't finished with this process but valuations are improving. It won't be an easy year but if you manage your risk properly, there are opportunities."

REUTERS