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A steady hand

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21 September 2018

With emerging markets entering bear territory, David Prosser explains why no action might be the best action for investors.

It’s one thing for advisers to explain theoretically to clients that investment in equities is a long-term pursuit with short-term ups and downs, but quite another to reassure when the tough times arrive. With emerging markets now officially in bear market territory – down more than 20 per cent from their peak – many investors will be feeling very uncomfortable with their losses. Some may be tempted to sell up.

Many investment companies invested in emerging markets are certainly feeling the strain. Several generalist funds are off by more than 10 per cent over the past month or so, while certain country or regional specialists in Latin America and Asia have been hit even harder.

Moreover, there’s little reason to expect a recovery any time soon; the consensus view amongst analysts is that emerging markets could continue falling for the rest of the year.

There are plenty of reasons to be gloomy. US interest rate rises have boosted the dollar, causing problems for emerging markets with dollar-denominated debt or dependent on US capital now more likely to stay at home. The threat of a trade war, which would hit developing economies particularly hard, looms large. Individual countries have particular problems, ranging from a regulatory crack down on credit in China to Turkey’s political issues.

How, then, to persuade investors not to panic? Well, one answer will certainly be to point to the long-term performance record of emerging markets. The average global emerging markets investment company has more than doubled shareholders’ money over the past decade, with some funds doing spectacularly better.

Aberdeen New Thai shares have risen 394 per cent over the past 10 years, India Capital Growth has gained 223 per cent and Fidelity China Special Situations is up by 157 per cent.

As for volatility, there is no denying these markets offer spills as well as thrills, as recent months have proved. But from investors’ perspective, the key is to focus on the more fundamental story – the potential of economies characterised by fast-growing populations (and particularly fast-expanding middle classes with spend power), increasing urbanisation and industrialisation, and maturing businesses benefiting from globalisation.

Advisers might also point to the wisdom of investing in these markets through investment companies rather than other types of collective investment vehicle. When investors know many of their peers are selling out of an asset class, the temptation is to join the rush before it becomes a rout. But investment companies offer some protection from this threat. Even if the shareholder base is dominated by panic sellers for a period, the fund manager can get on with the job of managing the underlying assets; the fund’s share price may slip to an ever-wider discount to the value of those assets but will eventually recover as normality returns. In open-ended funds, by contrast, assets may have to be sold to meet investor redemptions, requiring the manager to lock in losses rather than weather the storm.

What’s the message for advisers to emerging markets investors here? Well, point one is that they need to hold their nerve and keep their eye on the long-term prize; point two is to stick with an investment vehicle that is appropriate to the nature of the underlying asset – in this case a closed-ended fund.

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