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Time to look at the emerging market dividend story?

Recent soft-closures in the IMA Global Emerging Markets sector suggest investors should be looking at smaller portfolios.

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While the bulk of the assets in the IMA Global Emerging Markets sector are managed by a handful of giant funds, their soft-closure has left investors looking for other ways to play this space. Could the emerging market dividend story be an increasingly attractive option?

Jonathan Asante and Glen Finegan’s £4.4bn First State Global Emerging Markets Leaders fund will soft-close on 7 September while Aberdeen moved to slow flows into its global emerging markets funds by implementing a 2 per cent initial charge earlier this year.

The First State fund and Deevan Kaloo’s £8.3bn Aberdeen Global Emerging Markets Equity fund oversee more than two-fifths of the money in the 70-funds-strong IMA Global Emerging Markets sector, while Aberdeen also has several other large, soft-closed funds focused on the asset class.

However, a number of smaller portfolios are playing the dividend story, which is expected to see more interest as investors seek to maintain exposure to emerging markets and feed their continued hunger for income.

Hargreaves Lansdown investment analyst Richard Troue says: “Emerging market income has been growing in popularity and falling onto more and more investors’ radars.

“Also, most investors are aware of the capacity issues being faced by stalwarts such as Aberdeen and First State so they are on the lookout for alternatives and smaller, more nimble funds could be quite appealing.”

Emerging markets significantly underperformed the developed world in the first seven months of 2013. Over this time, the MSCI World index advanced 22.4 per cent while MSCI Emerging Markets shed just over 2 per cent.

Despite this, an allocation to the area is recommended and emerging market dividend specialists held up well when compared with their peer group. The average fund in the IMA Global Emerging Markets sector lost 1.7 per cent over the seven months, but Charlemagne Magna Emerging Markets Dividend posted a return of 6.58 per cent – beating First State Global Emerging Markets Leaders’ 5.2 per cent gain.

Meanwhile, Somerset Emerging Markets Dividend Growth has returned 2.3 per cent, JPM Emerging Markets Income is up 2.2 per cent and Newton Emerging Income rose 0.46 per cent. In contrast, Aberdeen Global Emerging Markets Equity underperformed with a 3.2 per cent fall, according to FE Analytics.

Chelsea Financial Services managing director Darius McDermott agrees these funds can be an attractive option: “We generally like these funds. Not that value means income or income means value, but there tends to be strong overlap between the two – and value outperforms in emerging markets over time.”

Julian Mayo, co-manager of the £105.1m Charlemagne Magna Emerging Markets Dividend fund, says emerging market companies tend to pay higher dividends than many investors give them credit for as the past 15 years has seen the rise of strong dividend culture in some parts of the space.

He says: “The average dividend yield in emerging markets is pretty much in line with developed markets, which is around the 2.5 to 3 per cent range.

“People tend to think of emerging markets as being very growth orientated and not very well governed from a shareholder return point of view but actually neither is true – companies are profit focused and they are focused on paying out a reasonable percentage of those profits to shareholders.”

Mayo highlights Taiwan, Thailand, South Africa, Saudi Arabia, Chile, Mexico and Brazil as particularly attractive hunting grounds in the space, adding investors could be surprised to learn some Chinese and Russian companies also pay strong dividends.

Troue points out the £250.5m Newton Emerging Income fund, which is managed by Jason Pidcock and Sophia Whitbread, was added to Hargreaves Lansdown’s Wealth 150 list of favourite funds when it launched in October 2012.

Although the fund has underperformed the sector over three and six months, he says: “It is managed by a team we know very well and feel like they have a bit of a longer track record established than others in the space. But we are watching the other players while they build up their track records.”

One of these watched funds is Edward Lam’s £315m Somerset Emerging Markets Dividend Growth fund, which has a research-driven approach to identify companies usually overlooked by other investors. For example, its top holding is Turkish acrylic fiber manufacturer Aksa Akrilik Kimya Sanayii.

McDermott, meanwhile, rates Richard Titherington’s £113.2m JPM Emerging Markets Income fund, which launched in July last year and appears on the Chelsea Selection list of funds.

He says: “Titherington has a longer term record on his investment trust and is not looking for a high income, so it is not getting stuck with high yielding stocks. It is looking for some income growth and has a total return mentality.”

Both Troue and McDermott expect to see greater interest in emerging market dividend funds as investors look outside the typical choices in the sector.

Troue sees emerging market dividend funds as more of a niche play and says they could be good candidates for satallite holdings alongside core positions in Aberdeen or First State’s offerings. McDermott, on the other hand, says some could be used as core and describes the route as “a good strategy for emerging markets full stop”.

Troue adds: “I think this is the kind of area where we will see a bit more competition creep in as the sector gains popularity.

“There are some firms like Somerset, Newton and Charlemagne that are establishing their presence and could have a bit of a first-mover advantage, especially for investors willing to back funds that are a bit smaller.”

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