One of the major aims is to allow investors away to diversify their income stream outside of the often concentrated UK dividend paying market. However, due to the nature of a company’s dividends, investors have also been using them as way to be “paid while they wait” for sentiment towards emerging market equities to turn more positive.
Certain experts, such as Hermes’ Jonathan Pines, have warned that emerging income stocks have reach very high levels of valuation as investors have been paying over-the-odds for safety.
However Rob Morgan, pensions and investment analyst at Charles Stanley Direct, says that investors can still afford, and should still continue, to hold emerging market equity income funds in their portfolio
“It’s potentially a bit of a crowded space, but don’t forget there is a large number of opportunities to choose from,” Morgan said.
“There is a good breadth of income paying sectors and companies, unlike in the UK equity income sector.”
“If you want to diversify, then I think emerging market income funds are a good option.”
Given that the majority of income-focused emerging market funds have only been launched over the last couple of years, not many have attracted a huge amount of inflows.
FE Alpha Manager Edward Lam’s Somerset Emerging Markets Dividend Growth fund and the Polar Capital Emerging Markets Income fund have two of the longest track records and are the two largest by assets under management (AUM).
Lam’s five crown rated fund was launched in March 2010, while the Polar Capital fund – which is headed up by William Calvert – was launched in January 2011.
The £608m Somerset Emerging Markets Dividend Growth fund has been the fifth best performing portfolio in the IMA Global Emerging Markets sector since its launch with its returns of 21.57 per cent, beating the MSCI Emerging Markets index – which both funds aim to beat – by more than 20 percentage points.
Since the £60m Polar Capital fund was launched, both portfolios have been top quartile performers.
Performance of funds vs sector and index since Jan 2009
Source: FE Analytics
However, the Somerset fund has returned 14 per cent over that time, while the Polar Capital fund has returned half that amount. As a point of comparison, the MSCI Emerging Markets index has lost 8.78 per cent since January 2011.
The Somerset fund has tended to deliver a more consistent discrete return, as well. For instance, our data shows that it has outperformed both the sector and its benchmark in each calendar year since its launch.
The Polar Capital fund on the other hand, outperformed the sector and index in 2011 and in 2012 – which was the only year that emerging markets have made a positive return.
While that would suggest the fund outperforms in rising markets, it has lost 0.75 per cent so far in 2014 while the MSCI Emerging Markets index has returned 2.01 per cent. The Somerset fund has continued to outperform this year with its returns of 2.1 per cent.
Performance of funds vs sector and index in 2014
Source: FE Analytics
However, Polar Capital Emerging Market Income’s recent performance could have been impacted Calvert’s overweight position in Russian equities, as the Russian market has fallen far this year as geo-political tensions with Ukraine have intensified.
Nevertheless, the fund has been bottom quartile over 12 months underperforming against Standard Life Investments Global Emerging Markets Equity Income, JPM Emerging Markets Income, Charlemagne Magna Emerging Markets Dividend and UBS Emerging Markets Equity Income in the process.
Those comparative returns are reflected in each fund’s capital preservation performance.
For example, while both have been top quartile for their maximum drawdown, downside risk, annualised volatility and Sharpe ratio over the last three years, the Somerset fund has better score in each of those ratios.
Due to the fact that the Polar Capital fund is domiciled in Ireland, data on its income generation isn’t available.
However, investors who bought £1,000 units in the Somerset three years ago would have earned £88.93 worth of income.
That doesn’t compare well to one of the other income-orientated funds which has a longer track record, Julian Mayo’s Charlemagne Magna Emerging Markets Dividend fund, which has generated £142 worth of income over three years on a £1,000 investment.
In fact, the Somerset has been the worst dividend-paying emerging market fund for income generation over the last year.
That could be well be a reflection of Lam’s aim to deliver a growing source of income instead of investing in already high-yielding stocks and the fact that he has kept a large amount of his portfolio in cash recently.
Nevertheless, Somerset Emerging Markets Dividend Growth currently only yields 1.6 per cent, which is a lot less than other funds in the sector.
Source: FE Analytics
Polar Capital Emerging Markets Income currently yields 4 per cent and, according to Calvert’s most recent note to investors, the fund has managed to increase its net distribution in each dividend payment since its launch.
While both funds tend to invest outside of the largest constituents of the index and, instead, have a mid-cap bias, the make-up of the Polar Capital and Somerset funds is very different.
For instance, Calvert currently has large overweight positions in Brazil, Thailand, Qatar, India and Russia and is considerably underweight China, Taiwan and South Korea. Lam, on the other hand, counts Korea, Taiwan and China as his three largest regional weightings.
Lam also holds around 16 per cent of his fund in cash, having told FE Trustnet earlier this year that he felt there would be a better time to buy into the market.
The expert's view
Morgan rates using emerging market equity income funds, but he favours Calvert’s Polar Capital fund due to the manager’s unconstrained approach.
“I like the fund. He has a high conviction style and will only hold a select number of stocks, so it is very much off-benchmark,” Morgan said.
“Calvert won’t invest in some the largest emerging market companies as he is more of a stock-picker.”
“Because of that, he will ultimately deviate from the index and so it could be for the more adventurous investor.”
Morgan says it is the type of fund that should benefit from a pick-up in sentiment towards the developing world has he is currently invested in more economically sensitive areas of the market.
Therefore, he isn’t surprised that the fund has slightly underperformed due to his decent exposure to South East Asia and Russia.
