Active management offers a strong and sustainable value proposition in emerging markets, believes Adriaan Pask, chief investment officer at PSG Wealth.
“Emerging markets can potentially generate higher returns than their developed-market counterparts, but these markets also offer unique risks and portfolios need to be carefully managed to control these risks,” he says.
Because emerging-market companies are not as well researched as their developed-market counterparts, active global managers/mandates have an opportunity to outperform.
The key to success in emerging markets, however, is to focus on quality research and careful risk management to help unlock market opportunities.
Pask points out that investors need to consider their portfolio construction holistically to ensure optimal diversification.
Emerging markets enjoy structural advantages (like growing populations and modernising economies) that mean they are likely to experience higher economic growth and thus offer potentially better returns.
Exposure to some companies listed on the JSE already offers some emerging market exposure (outside of South Africa) as these have moved beyond our borders to take advantage of other fast-growing markets or sectors (for example Naspers*, British American Tobacco, Anglo American and MTN, to name a few).
In addition, South African investors are not limited to SA only and foreign exchange controls have been relaxed considerably in recent years, making it easier to hold offshore diversified portfolios.
Individuals can invest R1m offshore annually without tax clearance, and take an additional R10m offshore per year, once they have obtained the necessary tax clearance from the South African Revenue Service (Sars).
However, investors should consider that foreign exchange controls impact retirement funds’ asset allocation.
Retirement funds are limited to a maximum of 30% of their assets invested offshore (including a 5% allocation to African assets). The biggest part of retirement fund assets therefore must remain invested domestically.
This limit remains relevant despite the fact that some JSE-listed SA companies also offer indirect emerging market exposure.
For many investors, retirement funds account for a substantial portion of their total portfolios and therefore they should consider this limitation on their overall asset allocation.
Local investors should bear these restrictions in mind and should not simply shy away from including additional emerging market and global exposure in the discretionary component of their portfolios.
“I would argue that, given the asset allocation constraints on retirement funds, notably from Regulation 28 of the Pension Funds Act, generally investors should consider including more foreign assets in their discretionary portfolios – so that the overall asset allocation of their portfolios is appropriately structured given market opportunities,” Pask states.
He however cautions that emerging markets have unique characteristics that mean portfolio risks should be carefully controlled.
Corporate governance and transparency remain significant challenges, as do market volatility and liquidity constraints.
“Careful portfolio construction, driven by quality research, can help to mitigate the risks of investing in emerging markets,” Pask continues, “provided you also actively manage portfolios as new risks emerge.”
Active management for him means remaining well-informed, gaining insights, and using these to unlock opportunities for investors on a continuous basis.
He believes that PSG Wealth’s research philosophy, with its strong emphasis on in-depth research, provides an advantage to investors when it comes to exploring the opportunities offered by emerging markets.
This is especially the case since emerging-markets assets are far less researched than the perennial favourites like Amazon, Apple, Johnson & Johnson, Microsoft or IBM.
This means that mispricing imbalances can arise more frequently and may offer a larger window of opportunity for active managers. With this in mind, active managers increase their likelihood of successfully taking advantage of mispricing in these markets.
Investors wanting to unlock the opportunities should partner with experts who understand how to actively manage the trade-off between risks and returns.
The PSG Wealth Global Creator Fund of Funds, for example, offers exposure to a selection of high-quality active managers that can allocate capital in a regionally unconstrained manner to suitable opportunities globally.
This fund mandate allows for actively managed exposure to emerging markets as the opportunities arise, and to allocate more to developing markets if the managers believe these offer better prospects.
The graph shows how the fund’s approach – and PSG’s philosophy – has paid off. The PSG Wealth Global Creator Fund of Funds has outperformed its benchmark, the GIFS Global Large-Cap Blend Equity, comfortably since inception (until 30 September 2017).
“We believe including suitable emerging-market exposure as part of an overall balanced portfolio will offer active managers the ability to potentially sweeten returns for their investors – but in doing so they will need to carefully balance potential risks with potential returns,” Pask concludes.
*finweek is a publication of Media24, a subsidiary of Naspers.
This article is part of the December 2017 FundFocus survey, which appeared in the 30 November edition of finweek. Buy and download the magazine here.