Emerging markets do not inspire confidence just yet

But while short-term fears may drive some ‘hot money’ out of volatile emerging markets, longer-term investors will testify that it is usually worth holding firm in order to benefit from capital growth which can often outstrip developed markets – especially if you are also targeting dividends.

Since Legal & General Investments launched its Asian Income fund in 2008, a further 16 funds have launched products focused on dividend-paying stocks in China, Asia and the wider emerging markets. In addition, in June this year Smith & Williamson Investment Management changed the mandate of Jane Andrews’ Far Eastern Growth fund to include a focus on income.

Mark Williams, lead manager of the £17.2m Liontrust Asia Income fund, launched in March 2012, says the growth in income-focused emerging markets funds has come as investors have sought alternative sources of income with bond yields at all-time lows, but it should not be seen as a new phenomenon.

“Because of the growth aspect of emerging markets people ignored the income aspects,” he says. “Even in 2003 you could have got a 4 per cent yield. The income story has been there but people have been happy to get a developed market yield and growth from elsewhere.”

This combination of income and strong capital growth has helped make income funds less volatile on average than their growth-only peers, according to research by Investment Adviser using data from FE Analytics.

Given the short term track records of many income funds, 12-month data was used to compare income-focused funds to the average volatility and capital growth from growth funds. The eight Asian equity income funds highlighted by Investment Adviser posted an average return of 13 per cent in the 12 months to October 25, while growth funds – the IMA Asia Pacific ex Japan sector with income funds removed – gained an average 9.3 per cent. The average volatility of both sets of funds was the same at 13.8 per cent.

It is a similar story in the emerging markets sector: five emerging markets income funds produced an average return of 6.1 per cent with an average volatility of 13.5 per cent. The IMA Global Emerging Markets sector – again with the income funds removed – posted an average return of 4.8 per cent and an average volatility of 14.2 per cent.

Many global equity income managers do not allocate large amounts to emerging markets because, although the dividends on offer can be high relative to some developed market companies, often smaller shareholders are not treated as on a par with major shareholders in some countries.

Mr Williams’ colleague Samantha Gleave, co-manager of the Liontrust Income fund, has negotiated around this problem by investing in one of the more advanced emerging economies: South Africa. Vodacom, the country’s leading telecoms provider, pays a healthy dividend while also tapping into other areas of Africa with low usage of mobile phones in order to grow market share. However, Henderson Global Equity Income fund co-manager Andrew Jones warns that slowing economic growth in some of the leading emerging markets may put pressure on earnings in the coming months.

The manager explains: “We have been underweight emerging markets which has been the right thing to do. Some quality income stocks have become overbought, and because growth is coming down we are concerned that earnings profiles will be hit and there may be downgrades.”

But Mr Williams claims the current environment in Asia is an encouraging one for income hunters precisely because markets have been falling. In the three years to October 29 the MSCI Emerging Markets index has traced a volatile path but gained nothing in terms of capital growth. All this means, however, is that company yields – the amount they pay to shareholders relative to share prices – has risen.

“It will probably continue to be like this until there is greater stability in global developed markets – and that is likely to be a slow long-term process,” Mr Williams adds.

Nick Reeve is deputy news editor at Investment Adviser

ASIAN INCOME IN NUMBERS

• 17

The number of dedicated Asian and emerging market income funds in the IMA sectors

• 6.1 per cent

Average 12-month return of emerging markets income funds

• 13 per cent

Average 12-month return of Asian income funds