Fund Spotlight: a smoother way to play fast-growing economies

There’s been a stark difference in performance between developed market and emerging market equities over the past few years. Over the three-year period to the end of March 2024, the MSCI World Index returned 11.8%, while the MCSI Emerging Markets (EM) Index fell -2.2%.

This divergence is now reflected in the price with emerging market stocks (MSCI EM Index) trading on a much lower price-to-earnings (P/E) ratio of 12.7x compared to developed market stocks at 19.1x (MSCI World Index). The P/E ratio is a key valuation metric that investors use to assess whether companies are a trading at a perceived “cheap” or “expensive” price.

Earnings growth for companies in emerging market economies are widely expected to recover during 2024 and this could be a catalyst to boost valuations in such stocks. Investors seeking to capture the growth potential of developing economies might consider this a favourable entry point.

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One option for investors to take advantage of low valuations is Capital Group New World (LUX) Z GBP. The fund invests in stocks of companies located in, or economically tied to, developing countries. This aligns with the goal of capturing the growth potential inherent in emerging markets while managing the associated risks diligently.

Capital Group take a team approach to fund management, which differs from the traditional model of having a few key decision makers supported by a team of analysts. The fund is managed by 12 investment professionals, who each independently run a portion of the portfolio. They work alongside each other with the overall aim of producing smoother returns for investors. Supporting the portfolio managers is a global team of research analysts who conduct in-depth research and are allocated part of the fund to manage. The result is a globally diversified portfolio with more than 400 holdings, which displays each manager’s best ideas. 

What does the fund invest in?

The strategy is focused on large, listed companies with strong growth potential. Eligible companies for investment must reach the threshold of 20% of assets in the developing world, or generate at least 20% of revenues from there. In addition, 35% of the fund must be always invested in companies listed in emerging markets. This strikes a balance between capturing the growth of emerging markets and mitigating risks.

Currently, allocation to the emerging markets region is 45%, with North America at 23.7% and Europe at 18.6%. Management increased the allocation to the emerging markets region in 2023 reflecting their positive outlook on opportunities in the broader EM universe including in Mexico, Brazil, India and Indonesia. They have become more selective with Chinese stocks. There is also a fixed income arm to the portfolio which currently holds 4% of assets.

How has the fund performed?

Over the past five years, the fund’s performance (up 7.2% on an annualised basis) falls short of its US-centric MSCI All Country World Index (up 11.6%), but it far outstrips returns of peers (up 2.2%) and the MSCI Emerging Market index (up 2.9%). The fund also demonstrated lesser volatility (the rate at which the price increases or decreases) during this period.

The standard deviation (a measure of volatility) for the MSCI EM index over five years was 19%, versus 17.7% for the MSCI ACWI and 13.2% for the fund, delivering on the aim of achieving a smoother returns profile for investors.

From a sector perspective, the fund takes a relatively cautious approach. Allocations to defensive sectors, which are not as sensitive to the economic cycle,including industrials (12%) and healthcare (11%), are the notable overweight positions compared to the MSCI EM Index, which holds (7%) and (3.7%) respectively. Having a higher allocation to these sectors contributes to keeping the volatility of the fund lower and generating steady returns.

However, in these sectors there are some exciting companies that are included in the fund's top 10 positions including Novo Nordisk A/S ADR (NYSE:NVO) and Eli Lilly and Co (NYSE:LLY),the two market-leading pharmaceutical companies in weight-loss drugs. Contributing to the success of these healthcare companies are rising disposable incomes in emerging markets.

Another interesting top 10 holding is Airbus SE (EURONEXT:AIR), whose primary business is the design and manufacture of commercial aircrafts. The firm is benefiting from increasing travel demand across emerging markets over the year.

All three stocks fit into a key theme in the portfolio, the “rise of the EM Consumer”,and have all posted strong double-digit returns over one year.

Digitisation across emerging markets is another key theme identified by management which drove the strong returns in 2023 and is expected to remain a tailwind in 2024.

The allocation to technology (14.9%) also deviates from the benchmark which holds (22.6%). Again, this is an important sector for the fund with the top two positions, Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM) and Microsoft Corp (NASDAQ:MSFT), each allocated 2.9% of the fund.

Source: Morningstar Total Returns (GBP) to 31/03/24.Past performance is not a guide to future performance.

Why do we recommend this fund?

Having exposure to developing economies remains an important allocation in a well-diversified portfolio.However, the backdrop in 2024 provides much uncertainty with election risks, geopolitical tensions and slowing economic growth in China some of the considerations investors in emerging market must consider. 

The approach taken by the Capital Group New World fund offers investors the ability to access the growth of emerging markets by holding companies listed in developed markets. This defensive approach tends to reduce volatility and add downside protection in market downturns, which could be an enticing factor for investors seeking to manage risk prudently.

Capital Group, in common with its other strategies, adopts a team approach to portfolio management. In addition, its strong analyst bench removes key-person risk.

For investors seeking exposure to emerging markets, this differentiated approach is one to consider.

The fund has a place as a core Emerging Markets strategy on ii’s Super 60 list of investment ideas.

Please find the factsheet here.