Are you interested in a mutual fund rated five star by Morningstar that has outperformed the emerging markets ETF (EEM, quote) in all but one of the last four years?
One of British American Tobacco's premium brands lit up around the world: Lucky Strike
According to its prospectus, the Virtus Emerging Markets Opportunities A fund (HEMZX, quote) had an annualized return of -45.90% in 2008, 48.52% in 2009, 28.15% in 2010 and -2.92% in 2011. The fund outperformed EEM all years except 2009. HEMZX’s return since its inception in 2006 is 10.44% and it has an expense ratio of 135 basis points.
As of May 31, 2012 the size of the fund was $3.8 billion, holding approximately 65 securities.
The top 10 holdings as of May 31, 2012 are the following:
1. British American Tobacco PLC (BTI, quote)
2. SABMiller PLC (SBMRY, quote)
4. Housing Development Finance Corp. Ltd. (HDFC, quote)
5. Companhia de Bebidas das Americas ADR (ABV, quote)
6. Companhia Energetica de Minas Gerais (CIG.C, quote)
7. Baidu Inc. ADR (BIDU, quote)
8. Wal-Mart de Mexico S.A.B. de C.V. ADR (WMMVY, quote)
9. Fomento Economico Mexicano S.A.B. de C.V. ADR (FMX, quote)
10. Power Assets Holdings Ltd. (HGKGY, quote)
Senior portfolio advisor for HEMZX Peter Newell says there’s high inherent risk investing in emerging markets because they are comprised of mostly energy, industrial, base materials and telecommunications companies. These types of companies, argues Newell, are not only cyclical in nature but also follow the global cycle. When commodity prices collapse, so do emerging markets.
The fund stays away from the index and avoids the vast majority of big names in emerging markets says Newell. Of the top 15 capitalized companies in emerging markets, HEMZX owns only one, Columbian Ecopetrol (EC, quote).
45% of the fund’s portfolio consists of consumer staples, mostly in India, Brazil, Indonesia, Mexico, China and Malaysia. Newell says large tobacco, beer, and consumer staple distributors in these countries are examples of good picks.
Thanks to the euro zone crisis and weak growth in the U.S., many emerging markets exports are under threat. Because of this HEMZX stays away from exporting companies and instead looks for companies that can earn consistently in all environments.
Most emerging market fund managers — especially ETFs, give you a little bit of everything, which Newell argues is not very wise. HEMZX invests only in companies with high return on equity, assets, and invested capital. A company also needs to have low debt, dominant market share, high barriers to entry, five years of sustainable earnings, durable demand — and it needs to be at a good price.
Newell says they are very careful when picking countries for the fund to invest in. HEMZX has never owned any Venezuelan or Argentinian companies. He adds they also do not own any Russian stocks because the country lacks rule of law, private property rights and equitable taxation. Not to mention that the Russian government can take over companies at any time, as it did with Yukos.
HEMZX reduces risk by owning non-correlated businesses, as most downturns don’t happen at the same time. A tobacco company’s downturn in Brazil for example, should not affect a tobacco company in India, explains Newell.
HEMZX is completely bottom up. As part of their screening process, they visit companies and their competitors. Newell says that assessing companies in emerging markets is much more difficult because many times they are not in business to reward shareholders.
HEMZX is not forced to own big companies like some indexes and fund managers are. Newell says they are compelled only to own what helps their clients achieve their investment objectives.