Genuinely active emerging market fund managers are shunning Chinese banks and industrials amid concerns over rising debt burdens and fears of overcapacity in sectors such as oil refining, steel, coal and aluminium.
Stockpicking fund managers are instead flooding into Asian technology-related stocks, such as chipmaker Taiwan Semiconductor, South Korea’s Samsung Electronics and Tencent, the Chinese internet group.
Analysis of fund managers’ holdings is generally distorted by the fact that many managers are “closet” trackers, sticking closely to the weightings of the index they are benchmarked against in order to reduce the risk of significantly underperforming this benchmark.
Other funds still are genuine index trackers, with the explicit goal of blindly replicating their underlying index.
As a result, the holdings and exposures of mutual funds are largely determined by the weightings of the indices they track, rather than being a reflection of their managers’ heartfelt investment views.
Steven Holden, founder of Copley Fund Research, which tracks 120 emerging market equity funds with combined assets of $228bn, has attempted to get around this problem by identifying 34 funds he believes are run by truly active bottom-up stockpickers with the freedom to deviate sharply from their underlying indices.
These funds, managed by big names such as BlackRock, Fidelity and JPMorgan, as well as smaller houses such as Lansforsakringar, Skagen and Seafarer Capital Partners, each have an “active share” — the degree to which their portfolio differs from its underlying index — of at least 70 per cent. They also hold fewer than 70 stocks, suggesting the managers are willing to make reasonably punchy bets.
Analysis of their holdings suggests fairly broad agreement as to which stocks are dogs that should be avoided at all costs.
China’s financial sector is top of the list. Just two of the 34 funds hold Bank of China, despite the heavyweight lender making up almost 1 per cent of the MSCI Emerging Market Index. Agricultural Bank of China, another of the country’s quartet of large state-controlled banks, is also on Copley’s “Unloved” list, those held by no more than three of these funds.
Overall, the 34 funds have an average exposure to Chinese financial stocks of just 0.98 per cent, a fraction of the sector’s 4.51 per cent weight in the MSCI EM index.
Moreover, of the 10 largest stocks on the Unloved list (table below), held by three or fewer funds, four are Chinese state-controlled companies: Bank of China, PetroChina, China Life Insurance and China Petroleum & Chemical, better known as Sinopec, as the table shows.
The aversion of genuine stock pickers extends right across China’s industrial sector: of the 34 such stocks in the MSCI EM index, every single one is on Copley’s list of Unloved stocks.
Just three of the 34 funds hold Russian gas powerhouse Gazprom, another state-controlled company, despite its large index weighting, and just one holds América Móvil, the Latin American telecoms company controlled by billionaire Carlos Slim, another heavyweight stock.
Equally out of favour are South African duo Steinhoff, an acquisition-hungry retailer, and Sasol, an energy and chemical company, as well as South Korea’s Hyundai Motor.
Taiwan’s Chunghwa Telecom is the largest company avoided by all of the 34 active funds, followed by country peers Formosa Plastics and Nan Ya Plastics.
All of the 22 Korean industrial stocks in the MSCI index feature on the Unloved index, alongside all 10 of the companies in three other niches: Indian materials stocks, Taiwanese consumer discretionary companies and Brazilian utilities.
In contrast, stockpickers have “an almost astonishing favouritism” towards Taiwan Semiconductor, says Mr Holden, with 30 of the 34 funds holding it.
Alongside Samsung and Tencent, other “Loved” stocks include Hong Kong-listed life insurer AIA Group; South Africa’s Naspers, whose prime assets are a 34 per cent stake in Tencent; telecoms group China Mobile; and Credicorp, the Peruvian financial group, perhaps explaining why so many investors were so opposed to to demote Peru from its EM index.
More broadly, these genuinely active fund managers love India at the moment, holding a big overweight position in the country, but are markedly underweight Greater China and South Korea, as the first bar chart shows.
Indeed, their exposure to India has doubled since 2012, rising particularly sharply in 2014 when Prime Minister Narendra Modi took office, as the first line graph shows.
Active managers have also increased their exposure to China/Hong Kong and Taiwan, despite still having underweight positions, but have sharply cut their weighting towards Brazil and, to a lesser degree, Russia amid recessions and the downturn in commodity markets.
On a sector basis, active managers remain enthused by the consumer story in emerging markets, despite an ongoing economic slowdown, holding overweight positions in both consumer staples and consumer discretionary stocks, as the second bar chart shows.
In contrast, active managers remain wary of the energy and materials sectors, holding underweight positions despite the fact that these sectors’ index weightings have fallen sharply, in line with tumbling commodity prices.
In contrast, their exposure to financial stocks and information technology companies is at its highest level for at least five years, an almost certainly far longer, as the second line graph depicts, while their holdings of energy, materials and telecoms companies has slid ever lower.