Emerging fears

The strong dollar is at the heart of it. Emerging market countries have loaded up on cheap dollar-denominated debt over the last decade but now it is proving difficult to service, as interest rates rise and QE is reined-in.

As a specialist emerging markets asset manager, FTSE 250 listed Ashmore Group (LSE: ASHM) should be in the firing line, but today’s trading update for the first quarter to 30 September is positive. It posted net inflows of $1.9bn as clients looked to take advantage of recent price volatility, a trend management expects to continue. 

Flowing in

Ashmore grew assets under management by a respectable 3.4% as $2.5bn of inflows lifted its total to $76.bn. It was further boosted by positive market movements of $300m and a similar amount of acquired assets.

CEO Mark Coombs said current uncertainty is leading to mis-pricing, which is throwing up buying opportunities. “We anticipate there will be more opportunities to buy attractively-valued assets and to embed long-term value into portfolios.” We like that kind of fighting talk at the Fool.

However

One concern is that the valuation doesn’t reflect current uncertainties, as it trades at 16.4 times forecast earnings. Also, share price performance does not reflect its buoyancy, with the stock trading 14% lower than five years ago. It does yield 4.8%, though, with cover of 1.3. My Foolish colleague Kevin Godbold admires its dividend potential. I just wish Ashmore was a mis-pricing opportunity too.

Fund manager Mark Mobius is the doyenne of emerging markets investing, and many still link his name with his trail-blazing investment trust Templeton Emerging Markets (LSE: TEM), which he helmed for 26 years before his recent replacement by Chetan Sehgal, who may be having a baptism of fire.

Interesting times

The fund is up just 22% measured over five years but still beat the wider investment trust global emerging markets sector, up 14% in that time. Over three years it is up 52%, against 29% for its sector. The new manager has had a rough ride, though, with the trust trading 14.5% lower than 12 months ago, worse performance than the sectoral dip of 11.2%.

The £1.67bn giant, launched in 1989, contains big and familiar tech names, including Chinese behemoths Alibaba Group and Tencent Holdings, Samsung Electronics and Taiwan Semiconductor Manufacturing, Indian bank ICICI and Unilever. Tencent has just suffered the biggest market value loss in history, a world record $220bn, hitting the trust’s performance.

Lonely are the brave

A quarter of the fund is invested across Asia-Pacific, with meaty exposure to South Korea and Taiwan, then a broad spread across Russia, Brazil, South Africa, India and Thailand. This gives you a good global reach. It is also trading at a discount of 11.9% to net asset value. Didn’t I say that you need to be brave, though?

However, some investors may see this as a contrarian opportunity to buy into weakness. Certainly, the escalating trade tensions and political instability should be taken seriously, but the sell-off in emerging markets may have been overdone. Some analysts reckon valuations have already adjusted sufficiently to compensate for the increased risks, while the longer-term outlook for emerging markets remains fundamentally attractive.

Discount to NAV

What’s more, there are a number of emerging market-focused investment trusts which continue to trade at a significant discount to their net asset values (NAVs), giving investors the opportunity to pick up shares in such funds for a price which is significantly below the value of their underlying investments.

One fund with a particularly wide discount to its NAV is the Templeton Emerging Markets Investment Trust (LSE: TEM). With a discount of just over 15%, the fund is trading at its widest discount to its NAV for nearly two years.

Aside from the recent sell-off in emerging markets, another cause for its widening discount may be the recent change in its fund manager. Veteran fund manager Mark Mobius, who had been at the helm of the fund for 26 years, retired earlier this year, and was replaced by Chetan Sehgal.

Consumer bias

In terms of allocation, the fund tilts towards countries such as China, South Korea, Brazil and Russia. Sector-wise, the trust is noticeably overweight towards consumer discretionary stocks, which account for 19.3% of its total assets, compared to just 9.5% of the benchmark MSCI Emerging Markets Index.

The consumer discretionary sector has been a persistent favourite for the fund, and is an area which seems best placed to benefit from domestic consumption growth in emerging markets. The consumption theme goes beyond goods and also include services, which are coming to represent a greater proportion of the emerging market economy. Demonstrating this, it has substantial exposure to the Chinese IT sector, via stakes in Naspers (6.1%), Alibaba (4.4%) and Tencent (3.2%).

Frontier markets

Despite the recent rout in emerging markets, frontier-markets funds have remained popular. Such funds invest in smaller countries which are at an earlier stage of economic or political development than many larger emerging markets. 

Frontier-markets funds haven’t quite entered into the mainstream, and there aren’t very many of them of them on the market — with a demand-supply imbalance, many investment trusts in this space trade at a modest premium.

One such fund is the BlackRock Frontiers Investment Trust (LSE: BRFI), which currently trades at a 4% premium to its NAV. Launched only back in 2010, the fund has realised impressive returns during its short life. Over the past five years, shares in the trust have delivered a cumulative return of 72% — nearly double the performance of its benchmark MSCI Frontier Markets Index, which gained only 39%.

Its most recent performance has been less remarkable, however. Shares in the fund are down 6% year-to-date, following a sell-off in Argentina, its biggest country exposure, and a general shift in sentiment away from riskier assets.

JPMorgan Emerging Markets Investment Trust (LSE: JMG) is a good example. Over the past five years, its share price has performed more than twice as well as the FTSE 100, though for the first three years it was lagging the index. And looking back as far as 2002, the investment trust has wiped the floor with the Footsie, despite some erratic spells.

The trust released first-half figures on Wednesday, and it’s been another good period for emerging markets as the benchmark MSCI Emerging Markets Index is up 11.3% in sterling terms. JPMorgan Emerging Markets pretty much tracked that with a return on net assets of +11.2%, though the return on the shares was an even better 12% due to a narrowing of the discount.

Volatility

That highlights one reason for volatility from a trust like this when compared to the underlying benchmark. When the benchmark is doing well, more investors are attracted to the trust’s shares and the price rises ahead of it — and the discount to net asset value falls. 

Similarly, if emerging markets have a bad spell, I’d expect more investors to sell, emerging markets investment trust discounts to widen, and the shares to underperform a falling market.

Assuming a long-term rising stock market (and I see no reason for emerging stock markets to not follow the same long-term upward trajectory as our familiar FTSE indices), I’d expect a strong performance. And JPMorgan Emerging Markets has actually outperformed its benchmark index over one, three, five and 10-year periods to 31 December 2017.

Chairman Sarah Arkle pointed to a “strong entrepreneurial spirit in China and other emerging economies” as one indicator that such markets will “remain fertile territory for equity investment“. I agree.

Track record

Templeton Emerging Markets Investment Trust (LSE: TEM), which has been investing in emerging markets for decades, provides an even starker example of the volatility you can expect.

For most of the past five years, its shares were badly behind the FTSE 100, falling by more than 40% by the beginning of 2016. But since then, they’ve put on a strong growth spurt to realign with the Footsie. Going back to 1995, we’ve seen a 600% rise in the trust while London’s top index has just about doubled.

If you feel that emerging markets means small upstart companies that may or may not come good, or companies trading in dodgy-looking economies, Templeton Emerging Markets is one that illustrates how wrong that can be. The biggest countries it invests in are China/Hong Kong, South Korea, and Taiwan — all with that same entrepreneurial spirit and with track records of economic growth.

One of the trust’s biggest holdings is Samsung Electronics, and ’emerging markets’ companies don’t come much more internationally successful than Samsung. Brilliance China Automotive Holdings is another big constituent of its portfolio. It has a tie-up with BMW through a joint venture to manufacture and distributes BMW cars in China. 

The trust even holds Unilever shares. A lot of investors might not realise that Unilever does far more of its business in Asia and other developing regions than it does here in the UK.

Templeton Emerging also invests in upcoming technology firms, which I think gives it an attractive mix.

Templeton Emerging Markets Investment Trust

The emerging markets offer exciting investment opportunities for long-term investors, in my opinion. Many emerging countries such as China, India and Taiwan are growing considerably faster than most developed countries, and as a result, over the long term, this growth should translate into powerful investment returns.

After a few poor years of returns between 2013-15, the sector appears to be on the up again, with the MSCI Emerging Markets USD Index returning 11% last year, and 28% this year up to the end of August. Investment trusts such as the Templeton Emerging Markets Investment Trust (LSE: TEM) are an effective way of gaining exposure to the asset class. 

Established in 1989, this trust’s objective is to provide long-term capital appreciation by investing in companies listed in emerging markets or that are listed in developed countries yet have significant operations in emerging markets. The trust’s NAV increased 125% for the 10-year period to the end of August. Ongoing charges are 1.12%.

Portfolio manager Carlos Hardenberg is particularly bullish about IT stocks in countries such as Taiwan and South Korea at present, stating that many of the companies that develop sensors and cameras for self-driving cars are based in these regions, and trading at attractive valuations.

At the end of August, the portfolio had the largest exposure to Hong Kong/China, South Korea and Taiwan, with the three top sectors being IT, financials and consumer discretionary. The top 10 holdings at the end of the month were:

Source: temit.co.uk

Emerging markets can be volatile, and therefore are most likely not suitable for risk-averse investors. However, for risk-tolerant investors, the Templeton Emerging Markets Investment trust could be a good way of gaining exposure to the asset class.

Polar Capital Technology Trust

Another trust with strong growth potential, in my opinion, is the Polar Capital Technology Trust (LSE: PCT). This one aims to generate long-term capital growth by investing in a diversified portfolio of technology companies across the world.

Technology is changing the world at a rapid rate right now, led by innovative companies such as Apple, Google and Amazon.com, and the Polar Capital Technology Trust looks to be an excellent vehicle for gaining exposure to such companies. The trust’s NAV has increased 173% in the last five years alone.

At the end of August, its top 10 holdings were:

Source: polarcapitaltechnologytrust.co.uk

With ongoing charges of a reasonable 1.16%, this trust looks to be an excellent way for UK investors to gain exposure to some of the world’s best technology companies.

Emerging markets

Templeton Emerging Markets (LSE: TEM) has had a great year thanks to the recovery in emerging market equities and the slump in the value of sterling. The trust’s shares are up 68% over the past 12-months, and even its discount to NAV has narrowed from a peak of above 20% to just 13%.

Today, valuations are not as cheap compared to a year ago, but emerging market equities still appear to be trading at a discount to developed markets. Commodity price volatility and Trump’s uncertain trade policy still pose big risks for emerging market investing. But the trust’s manager Carlos Hardenberg reckons developing economies are, in most cases, now more defensive and less vulnerable than they have been in the past.

Unquoted investments

Caledonia Investments (LSE: CLDN) has two interesting features. First, the trust is self managed, which means it employs an in-house investment fund manager, instead of hiring an external management company. This can allow it to take a long-term investment approach, which could give it an advantage over other investment companies.

Second, the trust invests a significant proportion of its portfolio value in unquoted companies — 42% at the end of January. This gives individual investors exposure to a sector which is generally difficult to get access to. The performance and valuations of unquoted companies tend to be less dependent on general stock market trends, which offers investors diversification benefits by reducing portfolio risk.

The trust has an impressive dividend track record, with 49 consecutive years of annual dividend increases under its belt. Shares in Caledonia Investments currently trade at a 16% discount to NAV and yield 1.9%, based on today’s share price of 2,770p.

Peer-to-peer lending

The Bank of England’s decision last August to reduce the base rate to 0.25% has piled even more downward pressure on returns offered by banks on cash balances. With interest rates so low, canny savers are having to look elsewhere to park their cash.

Investing in peer-to-peer lending can be a great way to boost your returns. But for investors who don’t want to go through the trouble of setting up their own account with a peer-to-peer lending platform, P2P Global Investments (LSE: P2P) offers an alternative route to gain access to the sector.

The investment trust, which focuses on buying peer-to-peer loans, offers investors exposure to the much larger US market, in addition to the UK, European and Australasian markets. This also adds diversification, which can help to reduce overall investment risk. In addition, the trust owns equity stakes in the lending platforms, which may offer investors potential capital gains on top of the steady income generated by its portfolio of loans.

Concerns about the lending practices of peer-to-peer platforms and their ability to withstand a more difficult economic environment have no doubt shaken confidence in the market. But with P2P Global Investments currently trading at a discount to NAV of 20%, I think these fears are overdone.

P2P Global Investments currently trades at a trailing dividend yield of 5.9%.

As investment trusts are traded like shares, their shares can trade at a premium or discount to the value of their assets. Demand and supply factors determine the value of the shares in investment trusts, and this usually means trusts that have been underperforming the sector usually trade at a discount to its net asset value (NAV). On the other hand, a strongly performing trust is likely to trade at a premium to its NAV.

Buying investment trusts that are trading at a discount to their NAV can be regarded as a bargain, as you are purchasing a collection of assets for less than the sum of its parts. But there is no guarantee that the discount will close and a sizeable discount could be regarded as a warning sign for poor management, excessive fees or lacklustre investment performances.

We will now look at whether it would be wise to invest in these five heavily discounted investment trusts.

Alliance Trust (LSE: ATST), the globally-focused investment trust, has been trading at a discount of more than 5% for a number of years now. With an investment return of just 1.4% in the first half of 2015, its recent performance has been underperforming its peers.

But management seems to be finally getting their act together. It has engaged with an activist hedge fund Elliott Advisors to tackle its bloated cost structure and improve its performance by increasing its share of equity investments.

The trust could take action to shrink its discount, by buying back shares in itself on the open market to reduce the discount in its shares. It did just that in 2011, when it bought back some £350 million worth of its own shares. With pressure from an activist investor, a return to share buybacks is quite likely.

Mercantile Investment Trust (LSE: MRC) is a UK-focused equity investment trust that has a long history of outperforming the sector. In the past year alone, the investment trust delivered a 20.9% after fees return on its NAV, which compares favourably to the peer average of 17.0% and the FTSE All Share total return of 5.0%. With an ongoing annual charge of just 0.50%, its 11.2% discount seems unjustified.

Templeton Emerging Markets Investment Trust (LSE: TEM) is one of the most popular emerging market investment trusts on the market, with assets under management totalling £1.63 billion. Unfortunately, its heavy exposure to China and Brazil has meant its investment performance has lagged its peer average in recent years.

Caledonia Investments (LSE: CLDN) has a significant proportion of its assets in private unquoted companies through direct holdings and private equity funds. Because of its heavy exposures to the UK, the rest of Europe and Asia, its investment performance has lagged the sector average. On top of this, it has a very high ongoing annual management charge of 2.61%.

Fidelity China Special Situations (LSE: FCSS) trades at a very substantial discount to its NAV, as the recent volatility in the Chinese equity markets and sell-off in emerging markets has reduced demand for the trust. As volatility settles down in China’s equity markets, the trust’s discount could narrow to its historical average of around 10%.

More information?

The Association of Investment Companies (AIC) publishes a wide range of data about investment trusts, including the premium/discount that they trade at, the amount of gearing used and their ongoing charges. Click here to see its latest published statistics.

One of the best ways to play this trend is via the Templeton Emerging Markets Inv Trust (LSE:TEM), one of the biggest trusts in the emerging markets sector. 

Templeton Emerging Markets has been on the scene for the past 25 years, and over this time the trust has only had one investment manager, Mark Mobius, who still sits at the helm.

With only one manager in place since inception, Templeton has been free to carry out long-term investment strategies, lasting decades and Mr Mobius has been able to grasp a solid understand of emerging market trends and developments. Indeed, he has recently issued some sage advice on the current emerging market sell-off, stating that;

 “I think most long-term investors realise they need to think before they leap [out] since recoveries can come very fast and it can be difficult to get back in when the recovery comes.”

Trust fundamentals 

So, what are trust’s key figures? Well, the fund has an annual management charge of 1% and the total expense ratio comes in at approximately 1.31%. At present, the trust offers a dividend yield of 1.13%, offsetting the bulk of these fees. 

The current net asset value per share is 601p; based on the trust’s current price this indicates a discount to NAV of 7.4%.

 27% of the fund is invested within Hong Kong and China, 13% is invested within Brazilian market, 12% within India and 12% in Thailand. The remaining 36% is invested within various other emerging markets. 

The secret to success

The Templeton Emerging Markets Trust’s largest holding is Brilliance China Automotive Holdings, a play on China’s rapidly expanding middle class, as more of the country’s population are able to afford cars and motor vehicles. Brilliance accounts for just under 9% of the trust’s assets. 

Tata Consultancy Services, an India IT conglomerate, is the trust’s second largest holding, amounting to around 6% of assets. The next few holdings are banks and financial services companies, 27% of the fund’s assets are devoted to the financial services sector.  

However, also sitting within the trust’s top ten holdings is Unilever (LSE:ULVR) (NYSE: UL.US). Consumer goods giant Unilever is a great play on emerging markets, as the company has a focused emerging markets growth strategy and currently generates around 50% of sales from developing markets. 

Unilever’s sales within emerging markets sales expanded 6.6% during the first quarter of this year and management increased the group’s interest in Hindustan Unilever Limited, from 52.48%, to 67.28%, which should add to the company’s bottom line going forward. 

Management has also stated their commitment to increase Unilever’s presence within Africa over the next few years.