Medalist Emerging-Markets Funds Open for Business
Several actively managed funds have closed in recent years, but investors still have many solid options to choose from.
The diversified emerging-markets category has grown the fastest in terms of the number of new funds compared with all other non-U.S. equity groups; just over one third of the offerings in the category opened within the past three years. The category has also seen several of its actively managed offerings shutter their doors to new investors over the same period, including Aberdeen Emerging Markets (ABEMX), Invesco Developing Markets (GTDDX), Lazard Emerging Markets Equity (LZOEX), Oppenheimer Developing Markets (ODMAX), and Virtus Emerging Markets Opportunities (HEMZX), all of which have Morningstar Analyst Ratings of Silver.
That's good news for investors in these funds because it should ensure their managers won't have to alter their strategies to accommodate huge inflows. However, this trend may be creating a bit of a roadblock for investors looking to add an emerging-markets equity holding or upgrade from their current fund. (Now is a contrarian time to look into such funds: The category is down 4% for the year to date through Aug. 13, one of the worst showings for any equity group, although of course it could fall further.)
The table below shows actively managed funds with Morningstar ratings of Gold, Silver, or Bronze that were open to new investors as of mid-August. A wide variety of investment styles is represented within this group.
A couple of these funds stand out in terms of their preference to err on the side of caution. That includes Gold-rated American Funds New World (NEWFX), which strikes a unique profile because it keeps around 40% of assets in developed-markets names and emerging-markets debt. The managers prefer to gain access to growth in emerging-markets indirectly on occasion, for example by owning Europe-based multinationals such as Novo Nordisk A/S (NOVO B) and Pernod Ricard NV (RI). They also invest roughly 10% of assets in emerging-markets bonds. Both tactics have helped make this one of the category's least-volatile options over time. Its seven lead managers run separate slices of this portfolio, but they all share a value-leaning, long-term-oriented process that typically targets large-cap stocks and allows for significant deviations from the MSCI Emerging Markets Index.
Silver-rated Harding Loevner Emerging Markets Advisor (HLEMX) takes a somewhat similar approach, focusing on large-cap companies with healthy balance sheets and clear competitive advantages. Its managers are also willing to diverge meaningfully from the sector weightings of the widely used MSCI index, with tech stocks getting a particularly large footprint lately (23% versus the index's 15%). Unlike the American Funds offering, its managers don't invest much in developed-markets companies or emerging-markets debt. Still, the managers' focus on the quality of the fund's holdings has helped keep a lid on risk relative to peers.
Investors that can handle a bit more volatility can consider GMO Emerging Markets III (GMOEX). This fund uses a unique top-down, quantitative approach. Reversion to the mean is the investment mantra at GMO, and so the models look for countries and sectors that are growing below their long-term averages but with the potential to recover. A separate momentum model works in tandem with the valuation-focused models. That has weakened the fund's downside performance in the past--most notably when it led to riskier positioning at the start of the market meltdown in late 2007--and could do so again in the future. And though the portfolio has more than 300 holdings, it continues to be bold from a sector and regional perspective compared with its S&P/IFC Composite Index benchmark.
The same goes for T. Rowe Price Emerging Markets Stock (PRMSX), because its managers go wherever they find companies with the best growth prospects. In the past year, two of those areas have been Brazilian and financials stocks, and the fund's weightings in those areas have been roughly 500 basis points higher than the MSCI benchmark's. Such leanings can have a big impact on performance, as has the managers' willingness to own faster-growing companies, which has resulted in supercharged rally performance (and sharper declines in sell-offs).
Finally, Parametric Emerging Markets Investor (EAEMX) and Thornburg Developing World (THDAX) are interesting options for investors looking for exposure across the market-cap spectrum. Putting a heavier focus on mid-caps and including high-single-digit stakes in small-cap stocks has kept these funds' average market caps well under half the $18 billion level of the MSCI Emerging Markets Index. The Parametric Emerging Markets fund is no fan of that bogy, however. Parametric considers this benchmark flawed as it puts too much emphasis on a few countries. Its quant-based approach divvies emerging-markets countries into four tiers based on market cap and liquidity, and the models allocate some assets to all four of them. As a result, this fund offers more exposure to smaller-cap firms as well as stakes in frontier markets such as Nigeria and Kazakhstan.
The manager at Thornburg Developing World runs a much more concentrated portfolio than most (40-50 names) and lets the best mix of undervalued and faster-growing names guide the construction. Interestingly, smaller-cap stocks often land among the manager's top 10 picks. One of these was Brazil-based Kroton Educacional, which sports an $8 billion market cap, as of June 30. Despite their inclusion of smaller-cap fare, the Parametric and Thornburg funds haven't been more volatile than the category norm over time.
Karin Anderson has a position in the following securities mentioned above: ODMAX, NEWFX. Find out about Morningstar’s editorial policies.