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Warning over targeting emerging markets for income

Warning over targeting emerging markets for income

Investors who flocked into emerging markets in search of a new source of attractive levels of income have come a cropper, according to market analysis.

In recent years investors have been driven to increasingly exotic destinations in search of income, spurring the growth of a new breed of emerging market equity income funds. These vehicles have promised income levels comparable to dividend-paying companies.

But the highest-yielding emerging market shares have underperformed lately, as stocks with high dividends were hit hardest by the news that the US central bank was set to end quantitative easing.

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Of the seven funds with an explicit income focus, only Somerset Emerging Markets Dividend Growth has beaten the IA Global Emerging Markets sector average or the MSCI Emerging Markets index from the start of July 2013 to February 19.

In that period, the MSCI Emerging Markets index has risen by 8.5 per cent but the yield-focused Dow Jones Emerging Market Selection Dividend index has dropped by 10.8 per cent.

The data will be a wake-up call to many investors, especially given many groups are launching new income propositions to tap into the expected demand set to be unleashed by April’s forthcoming pension reforms.

Edward Lam, manager of the Somerset Emerging Markets Dividend Growth fund, has managed to outperform his peers, but only by eschewing the higher-yielding emerging market stocks, leading to his fund yield coming in below the index.

Mr Lam claimed: “We would have done much worse if we had stuck to any conventional dividend-based strategy.”

His view has been echoed by other managers, who have eschewed investments in higher-yielding emerging market income stocks in recent years.

Jacob de Tusch-Lec, manager of the Artemis Global Equity Income fund, said he “dramatically” cut his emerging market holdings in June and July 2013 and had not returned in any meaningful way since.

Mr de Tusch-Lec said a major reason behind emerging market income underperformance was the 2013 sell-off sparked by Ben Bernanke, then US Federal Reserve chairman, who announced an imminent end to the US quantitative easing programme.

Ben Lofthouse, manager of the Henderson Global Equity Income fund, which has only 2.1 per cent in emerging markets, said another factor was the composition of dividend-paying emerging market indices.

He said 26 per cent of dividends in emerging markets were paid out by oil and gas firms, compared to 13 per cent globally, while the other dominant high-yielding companies were mining firms and banks, two extremely market-sensitive sectors.

Mr Lofthouse said such companies may be high-yielding now but offered little prospect of dividend growth and may even cut their payouts.