Oct 282011

Asian income funds and emerging market income funds may sound like a contradiction. After all, Asia and emerging markets are supposed to be growth investments. So why turn to a growth market for income?

In fact, Asian income and emerging market income are themes that make a lot of sense when choosing funds, for several reasons.

First, emerging market dividends are no myth. Many emerging markets stocks now have a culture of paying high dividends, so they make up a major part of investment returns in several countries. Dividends accounted for 30% of Asia ex Japan returns over the past decade – about the same as in developed markets.

Average yields of 3% or more are common in several emerging markets. That means investors can get a better yield than they would from most S&P 500 companies and on par with higher-yielding markets like the FTSE. At the same time, that yield should come with stronger dividend growth prospects than in developed economies.

But even if you’re don’t need to focus on income, Asian income funds and emerging market income funds can still be a good way to invest in these countries. Why? It helps impose investment discipline.

Demanding a certain level of income puts something of a cap on acceptable valuations. It stops you – or your fund manager – chasing expensive growth stories and overpaying for them.

And it also makes company management watch the cash. Firms that had a record of paying a decent share of their earnings as steady, sustained dividend tend to be more prudent and less inclined to squander shareholder funds.

So what are the options for a UK investor looking for an Asian income fund or an emerging market income fund? There are quite a number of choices and the range is growing all the time. Let’s take a look at what’s currently on offer.

Asian income funds – unit trusts and oeics

Among open-end funds, the best known is Newton Asian Income Fund, which has been running since 2005. The portfolio is weighted around 30% towards Australia, with Hong Kong, Singapore and Taiwan also being significant holdings. Financials are around 30%, followed by industrials and telecoms.

You’ll find that Australia, financials and telecoms tend to be major weightings in most Asian income funds. These are among the higher dividend parts of the market, so all Asian income managers will be selecting many of their stocks from there.

The Newton fund is on a trailing yield of 6% and a total expense ratio (TER) of 1.66%. This includes an annual management charge of 1.5% that can be cut to 1% by using discount brokers Cavendish Online or Alliance Trust Savings or 1.3% using Hargreaves Lansdown. The initial charge is 4%, which as usual can be avoided using a good discount broker.

Overall, I think this is a solid, well-managed fund. The portfolio seems conservative and not too risky, despite the high yield. While past performance is no guide to the future, it’s been a good performer over the last five years.

The Schroder Asian Income Fund has been running for just under five years and looks a similar proposition. It has broadly the same country weightings – although obviously with some differences in the portfolio – and a trailing dividend yield of 5.4%. The initial charge is up to 5.25%, the TER is 1.71% and the annual fee is 1.5%; this will be cut to 1% through Cavendish and Alliance Trust, or 1.25% through Hargreaves Lansdown.

Schroders also offers an ‘yield enhancement version’ of the same fund, the Schroder Asian Income Maximiser, which aims to boost the yield to 7% by selling covered calls against the funds holdings. Fees are the same as for the regular fund, but this version does not seem to be available through Alliance Trust.

Done correctly, a covered call strategy can deliver a decent additional income stream with little risk. On the downside, you give some of the potential capital gains if share prices rise strongly. I would prefer to hang on to the possible upside, but if you’re looking to Asian income funds for a rising income alone, rather than capital gains, this may be worth considering.

These two are probably the most established open-end Asian income funds in the UK, but there are a couple of others with a lower profile. The Invesco Perpetual Asian Equity Income Fund is relatively new, launched in early 2011.

The portfolio breakdown here is a bit different to the two funds above, with Hong Kong being the largest country at around 20%, followed by Australia and Korea. China, Taiwan and Singapore round out the major holdings at around 10% each. Financials again dominate at almost 40%, followed by materials and IT. The estimated yield is 3.9%.

The fund has an initial charge of up to 5%, an annual charge of 1.5% and the estimated TER is 1.75%. It’s available through Cavendish with a 0.5% discount on the annual charge.

There’s little track record to judge this fund by, but it doesn’t look terribly exciting at present. It may be worth watching to see how it progresses, but I would prefer to hold the Newton Asian Income Fund.

Then there’s the Legal & General Asian Income Trust, where the Australia and financials bias of these funds is more pronounced than ever. This fund is 40% invested in Australia, followed by Taiwan and Singapore. Financials are around 45% of the fund, with telecoms and IT the next largest sectors.

The historic yield is 4.4%. The initial charge is up to 5%, the TER is 1.71% and the annual fee is 1.5%; again, this falls to 1% at Cavendish and Alliance Trust and 1.25% through Hargreaves Lansdown.

Personally I would avoid this fund. It seems excessively geared to Australia, financials and Australian financials in particular: three of the top five holdings are Australian banks.

Finally, there’s the Henderson Asian Dividend Income Trust, which is a recent open-end variant on the firm’s better-known Far East Income Investment Trust. I’ll look at this as part of the investment trust section later.

The table below shows total returns (ie assuming reinvested dividends) for the funds that have been running for at least a couple of years below. Bear in mind that the track record is short and past performance is no sure guide to the future in any case.

 20062007200720092010YTD3 yrs
5 yrs
Legal & General Asian Income Trust46.52%20.66%-14.14%
Newton Asian Income Fund17.45%19.86%-25.17%49.81%31.98%-6.73%35.9%13.72%
Schroder Asian Income Fund20.9%-22.8%49%28.59%-15.04%29.98%

Emerging markets income funds – unit trusts and oeics

For a wider emerging markets income mandate, there are a couple of choices among the open-end funds. Both are fairly new.

One is the UBS Emerging Markets Equity Income Fund, launched in January 2011. Taiwan is the largest country holding in this at 20%, followed closely by South Africa and Hong Kong. Major sectors are financials, telecoms and IT. The historic yield is 5.5%.

The total expense ratio is 1.76%, with an annual fee is 1.5%, available through Cavendish with a 0.5% rebate; Hargreaves Lansdown also has the fund, but offers no discount beyond the usual waiver of the entry fee.

This looks a reasonably sound income play, but I would be more interested in the Somerset Emerging Dividend Growth Fund from boutique Somerset Capital Management, which has been running since early 2010.

This is more diversified with about 12% in South Africa and 10% in Taiwan, followed by Brazil, China and Chile. IT is the largest sector at 22%, followed by consumer staples and telecoms.

This fund has a lower target yield of around 3.5%, but as the name suggests it focuses on dividend growth as well as income.  I like the look of this fund not so much as a simple income play, but as a good-quality value-orientated emerging markets fund.

Since this is a small boutique, you won’t find the fund through any discount brokers. But Somerset is not currently charging any initial fee while the annual fee is already a low 1%, so there’s no need to search for discounts. The TER is 1.6%

Click for part two of the Asian income funds review – Asian income investment trusts and ETFs

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