Think outside the income box

Published by on 05 August 2010.
Last updated on 24 August 2011

chap with binoculars

If further proof were needed of the shift of economic power from west to east, it can be found in the launch of funds and investment companies whose primary aim is to earn income from emerging markets.

While Asian income vehicles have been around for several years, and some have impressive performance records, these newcomers plan to cast their net wider still in the search for dividend yield.

Their targets include Chile, Brazil, South Africa, Egypt, South Korea and Morocco - countries that not long ago would have been seen as far too perilous for western investors to venture into.

The impulse behind these new funds is not hard to discern. If it's income you want, you need a microscope to find it at home. With interest rates at rock bottom, and the authorities determined to keep them that way, savings in banks and building societies are offering a paltry return.

Company dividends, although providing better returns, are nevertheless sparse. Almost 60% of total income from the UK FTSE All-Share index comes from a mere 10 companies. And although they are blue chips, the experience of BP shows they are far from bulletproof.

Given that there is a large, unsatisfied demand for income from savings, particularly among those who are retired, some investment management companies have spotted an opportunity and been quick to seize it. Others are sure to follow.

First off the mark in March was the little-known Somerset Capital Management. Its offering - Somerset Emerging Markets Dividend Growth - is an open-ended fund and aims to yield 4.5% by investing mainly in equities. However, manager Edward Lam claims that many of the shares he holds could double their pay-outs within five or six years.

Where one boutique investment house leads, another follows. In June, Charlemagne Capital launched its Magna Emerging Markets Dividend Fund.

Chief investment officer Julian Mayo forecasts an average annual dividend yield of 6% from investing in countries as diverse as Taiwan, Turkey, Brazil, China, Russia, Qatar, Poland, Mexico, Korea, India, the Czech Republic and Chile.

The bigger players are also eager to join in and are launching closed-end investment companies. Aberdeen Asset Managers says its new Aberdeen Latin American Income Fund will yield 4.25% initially from investing 60% in listed companies and the remainder in sovereign bonds.

Meanwhile, JPMorgan has launched a Global Emerging Markets Income Trust with the aim of achieving a 4% yield at inception from investing in 50 to 70 holdings in emerging market equities.

Is it a trend or craze?

So are we witnessing a trend or a craze? Can emerging markets deliver all this promise being made on their behalf? By and large, analysts believe they can.

Hugo Shaw, investment adviser at discount broker Bestinvest, says: "These funds are certainly worth looking at.

"They do involve a higher risk than a typical income fund, but, as part of a balanced portfolio with an income bias, we would agree that you should have some equity exposure in emerging markets.

"However, as with all aspects of investing, you should not get too carried away with any one investment."

Mick Gilligan, head of research at stockbroker Killik & Co, says: "We are broadly in favour of these new funds and view them as a welcome addition to the London market.

"One caveat would be that you haven't got the same history of progressive dividend payments in a lot of emerging markets.

"For example, in Asia the culture tends to be based on a payout ratio, so that as profits fall then dividends tend to fall. That is something investors need to bear in mind.

"But if someone said they wanted to invest in emerging markets today and they are looking for income, we would highlight Utilico Emerging Markets investment trust, which invests in infrastructure and utilities, and therefore has a certain resilience that the others might not have. It currently trades on a 15% discount and yields 3.6%."

Underpinning the new confidence in investing for income in faraway places is the belief than many of these markets and economies have shaken off their reputations for instability and flaky corporate governance, and attained a maturity that increasingly inspires trust.

The proponents of the newer income funds are quick to cite additional reasons for their optimism. They point out that over the past two years corporate income has been more reliable in emerging markets than in developed ones.

In part, that is because some of those countries - particularly South Africa, Brazil, Chile and China - are focusing on dividends as a means of financing retirement through pension funds.

It seems the days when investors in the West saw emerging markets purely as sources of capital growth are disappearing.

The managers of the new income funds say they can find a significant number of companies that have paid dividends for 10 or 15 years, increasing them year-on-year.

Investors worried that capital growth will be neglected in the chase for income will be cheered to learn that the managers insist they will focus on total returns.

Oliver Crawley, Somerset Capital Management's spokesman, says: "The fund doesn't just target high-yielding stocks. That is not what we are trying to do.

"We are trying to target stocks that will pay dividends, but will also be growing businesses over time. What we want is a sustainable growing yield."

JPMorgan also says its new trust will provide equity income, coupled with capital growth, and Aberdeen says its Latin America Income investment company will invest in equities and debt, with the "heavy lifting" coming from bonds, and provide "a unique opportunity to diversify sources of income and capital through exposure to a structurally sound region in robust economic health".

What about the risk?
And as those countries increasingly shed the negative labels attached to them, so too do they lose their reputation for riskiness.

"There is a perception of increased risk, but we don't think it is correct," says Crawley. "The question you should be asking is do I want money in the West, not should I have money in emerging markets?

"And one of the nice things about looking at our fund from a sector basis is quite how diversified it is. This is not purely telecoms and utilities, where traditionally yields have been quite substantial.

"We also have quite a lot of positions in industrial companies, healthcare firms and consumer sectors such as supermarkets."

All of which sounds comfortably familiar. Almost western in fact.

This article was originally published in Money Observer - Moneywise's sister publication - in August 2010

Leave a comment