Somerset Capital Management’s Edward Lam has defended his emerging market equity income fund after its dividend payouts fell below the level seen on the wider market.
Investors turn to equity income funds in the hope that they will reward with higher dividend payouts than could otherwise be secured in more general funds that target shares for growth, not just income.
But Mr Lam’s Emerging Market Dividend Growth fund’s distribution yield fell to just 2.5 per cent at the end of August, compared with 2.7 per cent on the MSCI Emerging Markets index.
The fund’s stated aim is to create “a portfolio of stocks whose dividend is above that of the comparable universe”.
Mr Lam said the low dividend had come about because the higher dividend-paying stocks had become too expensive to hold, and he instead had been buying lower yielding companies, which in his view had better prospects of dividend growth.
“Because of the pursuit of income from investors globally, it has become quite apparent that there is a premium for stocks paying large dividends,” he said.
The manager admitted he had been getting “a bit” of pushback from clients for the fund’s below-index yield.
But he claimed “most clients that know us well are comfortable with what we are doing – they would prefer we maintain the quality of what we buy”.
While Mr Lam said that from a “personal point of view I do want the yield to be higher than it currently is”.
He said he would not be pushed into inferior higher yielding stocks just for the sake of a short-term dividend boost.
The issue mirrors that faced by UK equity income funds, many of which have been ejected from the IMA UK Equity Income sector for failing to match the requirements to deliver a yield in excess of 110 per cent of the FTSE All-Share index yield in rolling three-year periods.
High-profile funds hit by the sector requirements include funds previously managed by Neil Woodford but now run by Mark Barnett on Invesco Perpetual and the Henderson UK Equity Income fund run by James Henderson.
Mr Lam said in the current environment it was likely that “some of the better funds are suffering from a lack of yield”.
He said this was because “it is always possible to put together a list of high-yielding stocks, but it is much harder to make sure the stocks have a sustainable and growing dividend”.
In illustrating the expensive nature of high-yielding stocks currently in emerging markets, Mr Lam compared British American Tobacco’s subsidiary BAT Malaysia with Korean tyre company Nexen Tire.
He said BAT Malaysia, which currently has roughly a 4 per cent dividend yield but only a 4 per cent earnings yield, is currently trading at a price-to-earnings ratio of roughly 20x.
By contrast, Nexen Tire has only a 1 per cent dividend yield but has a 10 per cent earnings yield and is on a price-to-earnings ratio of 10x.
Mr Lam said while he still has a small holding in BAT Malaysia, Nexen Tire was a stock he had been actively adding to because he thought it had a better prospect of growing its dividend.
Emerging markets still a good long-term bet, says manager
Edward Lam has warned there are “not many things to suggest a turnaround” in emerging markets following a steep fall in the past month.
Emerging markets enjoyed a strong rally through the summer, but the onset of September marked a sell-off that has seen the MSCI Emerging Markets index drop by nearly 10 per cent in the past month.
And Mr Lam, whose Somerset Emerging Markets Dividend Growth fund has outperformed significantly both during the recent sell-off and since its launch, thinks the negative sentiment could continue in the short term.
But he said there were a few factors appearing that support the idea that for investors with a five- or 10-year view, now is a good time to invest in the region.
He said the sheer fact emerging markets had been in a bear market compared to developed markets for seven years meant investors are likely to be buying in at a “better than average price”.
He also said there was a strong correlation between developed economies shrinking their deficits and emerging markets underperforming.
Mr Lam said many developed economies were nearing the end of their deficit reduction and that an expansion of net spending, which historically correlates with strong emerging market performance, could follow.
