Interactive Investor

Fund Awards 2014: Emerging Markets

19th June 2014 11:09

Helen Pridham from interactive investor

Larger emerging markets fund winner: Somerset Emerging Markets Dividend Growth

After being the height of investment fashion a couple of years ago, emerging markets funds have fallen out of favour recently as markets have fallen. High demand at the height of the boom has led to several leading funds in the sector soft closing to new investors. Meanwhile, our award-winning fund was doing something rather unusual: offering income investors exposure to these markets.

Manager Edward Lam acknowledges that Somerset Emerging Markets Dividend Growth's income bias worked in its favour until a year or so ago, but that he has since tried to adjust his approach.

He says: "The period 2010-12 was supportive for dividend-focused investing in emerging markets, whereas 2013 to the present has been relatively weak for dividend investing. However, we have always tried to improve the portfolio, even in periods of good performance, because there are always weaknesses.

When selecting stocks, he looks for three main factors: quality, growth and valuation. "Dividend yield is an important criterion, but having a high dividend is not a substitute for good long-term management," he says.

General economic factors also enter the reckoning. "We try to establish when macro conditions are a major factor and should influence an investment decision, and when they are a minor factor," he explains. "For example, the currently low level of Egypt's foreign exchange reserves is a major factor, whereas elevated inflation in the Philippines is a minor factor."

One of Lam's best decisions was holding South African retail stocks. "They were unfashionable, and we spent a long time justifying the allocation to clients," he says.

The fund returned 14.7% in the three years to 1 March, compared with an average of -6.1% for the global emerging markets sector. In the past year, its ongoing charges figure was 1.6%.

Smaller emerging markets fund winner: UBS Emerging Markets Equity Income

The companies in which income-oriented funds invest tend to be more stable than those in a growth phase. Our winner in the smaller emerging markets funds category, UBS Emerging Markets Equity Income, has benefited from this. Although its managers, Projit Chatterjee and Urs Antonioli, aim to achieve some long-term capital appreciation, their principal focus is on generating income.

Their approach is to screen their investment universe for stocks that pay high and/or increasing dividends, factoring in current and forecast dividends. Forecast dividends are determined using input from in-house analysts as well as the consensus. They then take out stocks that look relatively overvalued. Valuations are based on their analysts' research and their "price/intrinsic value philosophy".

The fund also applies a qualitative screen. "We look to exclude stocks where dividends may not be sustainable, or those with weak company fundamentals and/or management, but include stocks where dividends are low and likely to increase," the managers explain.

When deciding where in emerging markets to invest, the managers say their primary consideration is finding the right companies. However, they add: "We recognise that, as well as company and industry fundamentals, macro and country factors - including monetary and fiscal policy, regulation and cultural behaviour - can influence equity portfolio returns." They take this information into account when considering individual stocks. The fund has a maximum limit of 25% exposure to a single country and 35% to a sector.

Although Chatterjee and Antonioli feel the short-term outlook for emerging markets is mixed, they point out that company valuations are attractive, both in absolute terms and historically. The two managers observe that they will remain underpinned by likely demographics, urbanisation and consumption growth trends in the coming decade.

The fund returned -1% in the three years to 1 March, against an average of -6.1% for the global emerging markets sector. In the past year its ongoing charges figure was 1.7%.