There have been unprecedented fund flows into emerging markets since the start of the year as investors have made the sector their top choice for re-embracing risk.
However, those flows have been concentrated in a few large emerging market groups – Aberdeen and First State in the UK, and Genesis and Vontobel in Europe. This has seen the soft closure of a number of these funds on liquidity concerns.
There is undoubtedly less liquidity in emerging markets, even among the mega caps. For example, China Telecom on the Hong Kong Stock Exchange had an average daily volume of just more than half that of Vodafone (64.96m v 118.42m). Volumes on the Shanghai Stock Exchange are even smaller. This makes buying and selling in any significant quantity difficult without moving the market.
This tends to be worse on the way out than on the way in. Caspar Rock, chief investment officer at Architas Multi-Manager, says the cliché runs that the definition of an emerging market is ‘one that is difficult to emerge from in an emergency’. Tim Cockerill, head of research at Rowan Dartington says: “Managers are aware of the time it will take to liquidate a sizable portion of their fund and as the fund grows, this time extends.”
There are also currency considerations. For the past few years, emerging market currencies have been on an upward trend and most currency analysts believe that will continue as emerging market economies get stronger. However, if there is a political or other shock, for example, and investors try to leave the currency and the stockmarket at the same time, the exit could become very small.
The other consideration is if a fund manager is forced to own too much of individual companies by virtue of their size. Mr Rock says: “If a manager is forced to own so much of a company that they have a declarable stake, it limits their freedom to manoeuvre.” There are takeover considerations and fund managers have to ‘show their hand’ at each turn.
Aberdeen and First State have tried to address the liquidity problem before it becomes a crisis. Aberdeen has soft-closed much of its global emerging market fund range, including its flagship Global Emerging Markets fund; First State has soft-closed a raft of funds, including its Indian Subcontinent, Greater China Growth and GEM Sustainability fund. Those measures have not yet been aggressive – they have hiked initial charges, stopped marketing, asked advisers to remove them from buy lists or raised the minimum investment level – but may become more so if these early measures are unsuccessful.
Mr Cockerill says that, for the time being, the soft closures may be less about liquidity and more about quality control: “As new money flows into a fund it has to be invested and managers don’t like to hold too large a (total) position in a stock so if a team manages a lot of money this can become an issue especially with mid-cap and small-cap stocks. And it is these stocks that can make significant contributions to performance. This what Aberdeen were talking about when they referred to not wanting to compromise their investment process.”
