Bloomberg/New York

This time last year, it looked like Goldman Sachs Group’s selection of emerging market up-and-comers was ready to fill the void left by shrinking investment returns in Brazil, Russia, India and China.
Share prices in these “Next 11” countries — places like the Philippines, Turkey and Mexico — were trading at all-time highs as foreign investors flooded their markets with cash. Inflows into Goldman Sachs’s US-domiciled Next 11 equity fund sent assets under management to twice the level of the firm’s Brics counterpart.
Now, though, the Next 11 countries are looking even worse for investors than the larger markets they were supposed to supplant. MSCI’s Next 11 equity gauge has tumbled 19% this year, versus a 14% slump for the Bric index. Foreign capital is rushing out, with the Goldman Sachs fund shrinking by almost half as losses deepened to 11% since its inception four years ago.
The turnaround shows how young populations and a rising middle class — characteristics that first lured Goldman Sachs to the Next 11 economies a decade ago — have failed to safeguard stock-market returns in a world facing higher US interest rates, tumbling commodity prices and a Chinese economic slowdown. For John-Paul Smith, one of the few strategists to accurately predict the losses in emerging markets, it also illustrates the dangers of grouping so many disparate countries into a single investment theme.
Money managers “are increasingly moving away from acronym- based investment,” said Smith, the former Deutsche Bank AG strategist who founded Ecstrat, a London-based research firm, last year. “Within emerging markets, it is difficult to think of a market that has a combination of attractive valuations and constructive policy developments.”
Katie Koch, a managing director at Goldman Sachs Asset Management, said that even with this year’s decline, the Next 11 fund’s return since its 2011 start still beat the MSCI Emerging Markets Index, which lost 16% during the period.
“While we are certainly disappointed that the asset class headwinds have weighed on N-11, the fund has performed as designed by outperforming broad emerging markets through a full market cycle,” Koch said in a statement.
As investor pessimism spreads to the smaller developing economies, capital outflows are deepening. Exchange-traded funds that invest in emerging markets recorded withdrawals of $1.65bn in the week ended Sept 4, a 10th week of outflows. Among the Next 11 markets, funds focused on South Korea and Mexico had the biggest losses. The group also includes Indonesia, Nigeria, Bangladesh, Egypt, Pakistan and Vietnam. Iran is a member, but the Goldman Sachs fund doesn’t invest in the country because of international sanctions over its nuclear programme.
“There’s just a lot of negative sentiment,” said Geoffrey Dennis, the head of global emerging-market strategy at UBS Group AG in Boston. “There are not many emerging markets that stand out against it, whether it’s Next-11 or Bric. It sucks in every one.”
The Next 11 countries’ shared vulnerabilities have been exposed by China’s slowdown and heightened anticipation of a Federal Reserve interest-rate increase as soon as this month. Weaker Chinese growth has hurt demand for Korean and Bangladeshi exports, along with the commodities produced by Mexico, Indonesia and Nigeria. Markets where foreign capital flows play an important role in driving investor sentiment — including Turkey and the Philippines — have slumped on concern international money managers will gravitate toward dollar assets as the Fed boosts rates.
Some members of the group have problems of their own making. In Turkey, the government’s failure to form a coalition after June 7 elections has sapped investor confidence and pushed the lira to a record low. Turkiye Garanti Bankasi, the nation’s largest lender and one of the top holdings in Goldman Sachs’s Next 11 fund as of June, has tumbled 26% this year.
In Nigeria, President Muhammadu Buhari has yet to name a cabinet after coming to power in May, while the central bank’s efforts to defend the naira are depleting foreign reserves. Nigerian Breweries, the local unit of Amsterdam-based Heineken, has dropped 25% this year.
The MSCI gauge for emerging markets was little changed at 8:19am in New York, trading about 4% above the six-year low reached last month.
For Alex Wolf, an economist at Standard Life Investments, country-specific drivers of performance have become too important for investors to rely on groupings like the Next 11 to determine their holdings.
“There couldn’t be bigger differences between these countries: the growth model, the outlook, the demographics and the natural resources,” said Wolf. “You have to look at each country individually.”
There are some bright spots. Vietnam’s benchmark VN Index has gained 4.9% this year, helped by rising exports and a government push to become an Asian manufacturing hub. Economic growth quickened to 6.4% in the second quarter from 6.1% during the previous three months.
Over the longer term, shares in the Next 11 have been a decent bet. The MSCI Next 11 ex Iran GDP Weighted Index climbed 61% including dividends from the end of 2005, when former Goldman Sachs economist Jim O’Neill coined the term, through August. That tops a 46% return from the MSCI Emerging Markets Index, though it lags behind a 94% gain in the Standard & Poor’s 500 Index.
O’Neill, who stepped down as the chairman of Goldman Sachs Asset Management in 2013 and became commercial secretary to the UK Treasury in May, didn’t reply to an e-mailed request for comment.
So far, the Next 11’s impact on the world economy has been modest. With a combined gross domestic product of $6.5tn, they accounted for about 8% of global output last year, up from 7% a decade earlier, according to data compiled by Bloomberg. The share of Brics nations more than doubled to 21% during the same period.
As the effects of an unprecedented economic boom in China and three decades of declining interest rates in the US wear off, it’s no longer inevitable that less-developed countries will deliver attractive investment returns, according to Stephen Jen, the co-founder of London-based hedge fund SLJ Macro Partners.
“Too much long-term money has been invested in this space that was based on simplistic logic related to population growth, and that poor countries must somehow become wealthier,” Jen, a former economist at the International Monetary Fund, said in a note on August 31. “There have been plenty of poor countries that stayed poor.”