I have been a fan of emerging markets for more than 25 years. In fact, I set up a monthly savings plan into an emerging markets fund for my son when he was born 22 years ago. It has worked out extremely well so far – despite many people at the time saying I was throwing money down the drain. Back then, emerging markets were unpopular, having had a dismal run. However, they turned out to be a great growth opportunity for the next couple of decades.
It was always frustrating, though, that they did not satisfy those who wanted an income from their investments. Rather than pay dividends, emerging-market companies often reinvested cash in projects they believed would produce better returns for shareholders. While it meant the prospects for capital growth were excellent, income was hard to find. However, times have changed and a dividend culture has taken hold across many parts of the developing world.
Today there are proportionately more companies paying dividends in emerging markets than in developed markets, with Latin America and Asia particularly bountiful hunting grounds. In fact, emerging market companies on the whole are growing their dividends faster. It is now possible to capture the potential of emerging markets and the attractive dividends of 'equity income' in a single fund. Newton Emerging Income Fund, launching on 4 October aims to do exactly this.
Newton has been well aware of the power of dividends for many years. In the 1980s, the top-performing Newton Income and Newton Higher Income funds were popular with investors. They realised they could expand this further, launching Global, European, and, most recently, the highly successful Asian Income fund under Jason Pidcock. The new Emerging Income fund will be run by Mr Pidcock alongside Sophia Whitbread and contains 30 per cent commonality with Asian Income.
The managers believe a dividend-focused approach to investing in emerging markets has benefits for all investors. Paying dividends is a sign of strength and disciplined management. It means companies have to consistently generate earnings and manage their cash prudently. Such companies often have significant potential for growth too.
Ms Whitbread and Mr Pidcock are looking for growth in dividends rather than simply targeting firms with the highest payouts. By considering the likely future earnings of a company, they can assess how dividends might be sustained or increased over time. The aim will be to yield at least 15 per cent over the benchmark (the FT All World Emerging Index), which should mean the fund yields about 4 per cent at the outset.
The portfolio will be split roughly equally between Asian emerging markets and areas outside Asia. At present the team is most positive on South America, South-East Asia and South Africa. India, however, is likely to start with a zero weighting because of low dividend payouts there, as will Russia because of concerns over the sensitivity of stocks to the oil price, as well as general standards of corporate governance. The managers can also buy developed-world shares providing most of the firm's profits come from emerging markets.
In terms of sectors, real estate, telecoms and consumer goods will be prevalent. The fund is likely to be positioned in well-established larger companies, which allow sufficient liquidity to trade in and out.
You may believe that the emerging-market income story is a flash in the pan. After all, companies could revert to a policy of low payouts, electing instead to reinvest cash by buying rivals or setting up new businesses. However, Mr Pidcock thinks that is unlikely. He prefers consolidated markets and industries where the scope for acquisitions is limited. He also believes companies are alert to the growing influence of domestic pension funds, which are increasing institutional demand for income.
An investment in this area is high risk, so a long-term horizon is essential, allowing time to ride out the inevitable ups and downs. However, if you are looking to diversify an income portfolio and gain exposure to some of the world's fastest growing economies, or you are simply looking for the best long-term returns from emerging markets, this new fund could be of interest.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit www.h.l.co.uk/independentReuse content