Are Emerging Markets Too Risky for Income Investors?

Emerging market equities are known for their volatility - so should they even be considered for income investing?

Emma Wall 11 September, 2013 | 2:38PM
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Emerging markets used to look like an easy play. In the decade to 2007, certain country specific funds - such as the JPMorgan Indian Investment Trust - seemed to have a one-way ticket to profit. 

But then the global recession hit, the Chinese economy slowed, and emerging markets were revealed to be a pretty risky bet. 

Investing in stock markets that are naive, in companies that have yet to adopt Western corporate governance, can trip up even the most experienced of professionals. 

Fidelity's star manager Anthony Bolton fell foul of fraud when choosing holdings for his China Special Situations fund - and he had more than 20 years’ experience. 

"Growth forecasts for emerging markets has been revised downward pretty much across the board, at least for the big four BRICs, that’s Brazil, Russia, India and China," said Morningstar analyst Oliver Kettlewell.

"That’s a reversal of a previous trend, whereby emerging markets in previous years were hitting or even exceeding growth forecasts."

It is not just the economic figures that have been poor – corporates have also shown signs of struggle. Earnings have underperformed expectations and profits have been hit by wage inflation and commodity price rises.

Wage hikes in China and Thailand have even caused some multi-national corporations to repatriate their factories to the US.

The last three years has been particularly tough for emerging markets, and the imminent wind down of quantitative easing in the US has hit markets further.

Income investors rely on a steady stream of pay-outs, they are not known for their risky stance. So can these volatile emerging markets offer anything to income investors?

Omar Negyal of JP Morgan Emerging Market Income Investment Trust admits that the emerging markets and dividends may not automatically be associated for investors, but the combination of income and growth has in fact been a powerful source of total returns in emerging markets.

"Emerging market income ticks a lot of boxes," he said. "It offers UK investors an opportunity to diversify away from traditional UK income sources, which are very concentrated, into a global asset class that is diversified across countries, currencies, sectors and companies and becoming an increasingly important part of world equity markets.

"Diversification benefits aside, we believe the key attraction for a UK investor is the potential for the combination of capital growth and income, which, compounded over long periods, can produce significantly stronger returns."

Income can also help to diminish the risk associated with investing in emerging markets. The ability to pay a dividend is often an indicator of a healthy balance book - and not something which a small or unestablished company is capable of. 

As emerging market companies mature, so investors should expect dividend growth. The universe is already significantly larger than that of the UK - today there are 366 emerging market companies with a yield of 4%, and a market capitalisation of at least $1 billion. Only 59 stocks in the UK match those criteria.

Charlemagne Capital Magna Emerging Markets Dividend Fund manager Julian Mayo said that emerging market equities are also cheap compared to emerging market debt.

“The lengthy bull market in emerging market debt has resulted in a historically high reverse yield gap, which suggests equities are cheap in relative terms,” he said.

“Emerging market equities also look cheap when compared to developed market equities, which suggests that the market has overly punished the asset class.”

Emerging market income funds are a relatively new phenomenon, and so not all funds have a long track record by which to measure performance.  

The JPMorgan Emerging Markets Income trust has a Bronze rating. But for investors comfortable with region specific funds, Newton Asian Income has been awarded a Silver rating by Morningstar analysts and Schroder Asian Income is rated Bronze

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Emma Wall  is former Senior International Editor for Morningstar