Invesco Emerging Markets ex China UK Z Acc
Why is this fund on our radar?
Emerging markets (EM) are countries that are progressing to reach the levels of economic development and stock market sophistication of developed markets such as the UK or US. The EM universe contains a broad set of countries with significant growth potential for many different reasons. The best example is China, which has grown to the world’s second largest economy in just a few decades and has delivered exceptional returns for investors along the way.
However, many investors are now put off by China’s dominance, political tensions with the USA and its government’s interference in markets, hence Invesco Emerging Markets ex China, which offers exposure to the growth potential of the asset class, whilst avoiding the numerous concerns with China. This differentiated approach has enabled the fund to deliver very different returns to the peer group. This is in part due to the managers’ contrarian approach, which means looking at the most out-of-favour stocks and buying ahead of a potential recovery. This approach, as well as the fact the managers don’t invest in EM’s largest country, has meant the fund scores highest on our analysis for being most different to the period group whilst still generating good performance, and having done so on a consistent basis.
Skip to Our VerdictPerformance
Managers Charles Bond and James McDermottroe aim to generate an annualised return in the double-digits over a three-to-five-year investment cycle, buying under-appreciated companies and waiting for a recovery to take effect.
Whilst stock selection is designed to be the primary driver of performance, the managers’ focus on undervalued companies means the fund is likely to have a bias to the value style of investing which involves focusing on those with depressed share prices. As such, the fund is likely to perform best when this style is in favour, typically when interest rates are high or rising. By contrast, the fund could underperform in a growth market when companies increasing earnings, regardless of their valuations are most in favour, often when interest rates are low or falling.
Similarly, the contrarian approach means the fund is better placed to capture turning points in markets, when sectors or countries that had been out of favour return to popularity. The EM index is very broad, and can be subject to quick changes in sentiment, therefore we believe Charles and James’ approach is well placed to capture the sector’s nuances. However, there may be periods where the market is driven by a narrow band of certain stocks, and this can be a headwind to their contrarian nature, as they will often sell stocks as they rise, rather than running their winners. That said, it is expected that these factors will even out over the course of the cycle, leaving the primary focus of stock selection to drive outperformance.
The exclusion of China will of course have consequences for the fund. The country is the largest in the EM index, and therefore the strength or weakness of the country will have an impact on relative performance. Over much of the past five years, China has struggled, leading to the fund delivering strong outperformance versus a broad EM index, although this could be the reverse should China have a bounce back. In this period, Charles took over management on 31/03/2022. On this date, the fund absorbed the assets of other Invesco vehicles.
five-year performance
Past performance is not a reliable indicator of future results
Portfolio
Charles and James have a contrarian mindset, whereby they look at unloved parts of the market for undervalued opportunities. This is not simply picking poor performers and hoping for a recovery, they target companies with sustainable business models, generating good cash flows that are not too indebted, and are run by pragmatic management teams. Valuations remain paramount, with the managers aiming to identify good companies, that are temporarily trading what they believe to be their intrinsic value.
Their investable universe contains 600 to 700 companies, which is narrowed down through extensive company-specific analysis to create a shortlist of between 60 and 70 stocks. From here, the managers undertake fundamental analysis including meeting a company’s management team to establish the firm’s competitive positioning and quality of management, to a final portfolio of c. 45 stocks. Each new idea will need to offer balance to the portfolio, ensuring it is not tilted to any one specific factor.
style split
That said, the valuation focus and contrarian mindset means the fund can be biased to areas such as materials and banks. Conversely, the managers have had large weights in technology as, despite the higher absolute valuations, they believe the growth prospects remain underappreciated. On a country basis, there are often tilts towards countries with more attractively valued countries, such as Korea, whilst underweights to countries with higher stock valuations like India are not uncommon. Whilst the EM universe is very broad, Charles and James are able to invest outside of this, including some holdings in US-listed companies, if their primary activities are in EMs.
Our Verdict
The size and growth potential of emerging markets makes them a compelling asset class, in our view, although investors are understandably cautious considering some of the inherent risks. One major factor behind this caution is China, and the risk of government intervention in capital markets. However, as the world’s second largest economy it makes up nearly a third of the emerging markets when it comes to the size of their stock markets, meaning it dominates EM portfolios and is difficult to avoid. Therefore, with Invesco Emerging Markets ex-China, investors can invest in the exciting growth potential of the broader emerging market asset class, without the risk of direct China exposure. We believe this not only makes the fund an attractive portfolio option in isolation but also means it could be paired with a dedicated China holding to enable greater flexibility.
Charles and James’ contrarian approach also helps the fund standout, in our view. By targeting overlooked areas, the portfolio is likely to look very different to other options in the sector therefore the fund offers something very different to a passive investment. Furthermore, we believe this approach could do best at market turning points, a common occurrence in emerging markets, leading Charles and James to be well-placed to harness the region’s volatility into returns.
Key Risks
- Contrarian mindset can be a headwind when the market is momentum-driven
- Whilst a specialist strategy, fund’s peer group can invest in China meaning performance versus the sector will be very different
- Very active country positioning (in China and India) brings risks as well as opportunities
