Both the IMA Asia Pacific ex Japan and IMA Global Emerging Markets sectors have struggled recently, but investor favourites such as the Schroder Asian Income and Income Maximiser funds and both of Newton’s Asian and Emerging Income funds have found it tough going.
This will be particularly concerning for investors who think the funds offer a way to get lower-risk exposure to the developing world.
Concerns over the Fed tapering its QE programme, possible rises in interest rates and the high valuations of emerging market defensive income-paying stocks are all being blamed for the poor performance of these funds.
The £4.1bn Newton Asian Income had a difficult six months, with losses of 6.32 per cent. Both the Schroder Asian Income and Asian Income Maximiser funds also sit in the bottom quartile.
This is in stark contrast to their longer-term performance, as Newton Asian Income is the best-performing fund in the sector over three years and Schroder Asian Income is the fifth best.
Performance of funds vs sectors
| Name | 6m returns (%) |
Rank in sector |
|---|---|---|
| IMA Asia Pacific ex Japan sector | -2.84 | N/A |
| Invesco Perp - Asian Equity Income | -3.86 | 49/84 |
| Liontrust - Asia Income | -5.34 | 63/84 |
| Henderson - Asian Dividend Income | -5.79 | 69/84 |
| Schroder - Asian Income | -5.9 | 70/84 |
| Schroder - Asian Income Maximiser | -6.07 | 71/84 |
| Newton - Asian Income | -6.32 | 73/84 |
| IMA Global Emerging Markets sector | -3.88 | N/A |
| UBS - Emerging Markets Equity Income | -4.24 | 37/69 |
| Somerset - Emerging Markets Dividend Growth | -4.56 | 43/69 |
| Polar Capital - Emerging Markets Income | -5.33 | 53/69 |
| Newton - Emerging Income | -9.29 | 69/69 |
Source: FE Analytics
Henderson Asian Dividend Income is in the bottom quartile over the period while Liontrust Asia Income and Invesco Perpetual Asian Equity Income are in the third quartile.
In the IMA Global Equity Income sector, UBS Emerging Markets Equity Income and Polar Capital Emerging Markets Income are both bottom-quartile over six months while Somerset Emerging Markets Dividend Growth is third-quartile.
"The income strategy is being hit by tapering talk: those funds have done very well until the past few months but people have taken a little bit of a step back from income funds," said Juliet Schooling-Latter, head of research at Chelsea Financial.
"Tapering means the potential for higher interest rates, which encourages some of the money that has been pouring in to dividend-producing equities to move back out into something safer."
Schooling-Latter explains that the prospect of QE being tapered and rising rates will encourage them to pull their money from emerging markets and high-yielding equities at the same time.
Jonathan Pines, manager of the Hermes Asia ex Japan Equity fund, says this is a long-term trend and income funds that focus on the developing world will continue to struggle on a relative basis. His strategy is to invest in companies that offer good value, meaning he avoids expensive areas.
Pines says that one of the problems with some income managers is that they have been massively over-paying for safety.
"Some [managers] are making a big mistake, as though they are buying quality companies, they are buying them at an extraordinary price," he commented.
The manager describes defensive companies in south-east Asia as the "ground-zero" of overvaluation, and points to Unilever Indonesia as a prime example.
"Unilever Indonesia is clearly a high-quality company as its earnings per share have increased five-fold over 10 years and in a predictable way. However, the market loves it and its share price has increased 18-fold over that time," he said.
"This is because investors have been going for quality at any price, which is due to the proliferation of income funds," he added.
Pines understands why investors have used this strategy, given the lack of yield available from cash and the bond market; however, he says a focus on quality at any price will mean these income funds will continue to underperform.
Instead of investing in these "expensive defensives", he is concentrating on pro-cyclical stocks and companies listed in bombed-out regions such as China.
"There are a number of reasons why some fund managers are getting it wrong," Pines continued.
"The focus on finding yield has forced people to become increasingly short-termist and to stay away from cyclicals at all costs. However, this could cause a problem when the market realises that these defensive stocks or regions such as south east Asia are ridiculously expensive."
Pines’ strategy has worked so far, as his Hermes Asia ex Japan Equity fund is the best-performing portfolio in the sector since its launch in October 2012 with returns of 27.56 per cent. This is more than five times the returns of its MSCI Asia ex Japan IMI benchmark.
Performance of fund vs sector and index since Oct 2012
Source: FE Analytics
The manager also says that when the Fed tapers its asset-purchasing programme, south-east Asian defensive income-producing stocks will be hit the hardest because they are trading at very high valuations.
However, Schooling-Latter says investors shouldn’t over-react to these concerns.
"Investors in the emerging market income story have been rewarded in recent years, and in the longer term it’s still a good place to be," she added.
Nevertheless, it isn’t just in the Asian and Emerging Markets sectors where income funds have struggled.
Our data shows that the Legg Mason US Equity Income, Neptune US Income, Jupiter North American and JPM US Equity Income funds have all been bottom-quartile performers in the IMA North America sector over the past six months.
Performance of funds vs sector over six months
Source: FE Analytics
While investors would still have made money from these funds over the last half year, it has been the higher risk portfolios such as Bill Miller’s Legg Mason Capital Management Opportunity fund and AXA Framlington American Growth that have performed the best, with returns of more than 15 per cent.