Somerset: Income Investors Look East for Dividends

Emerging markets investor Edward Lam of Somerset Capital looks for stocks offering dividend growth - and has found Eastern European banks fit the bill

Emma Wall 28 February, 2017 | 11:54AM
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Emma Wall: Hello, and welcome to the Morningstar Series, 'Why Should I Invest With You'. I am Emma Wall, and I am joined today by Edward Lam, Manager of the Somerset Emerging Markets Dividend Growth Fund.

Hello, Edward.

Edward Lam: Good Morning, Emma.

Wall: So your fund because of that dividend growth focus looks quite different to a normal emerging markets fund. One of the key difference is your allocations towards emerging Europe. Lot of emerging markets funds at the moment look very Asia-centric, but you have money in Eastern Europe.

Lam: Yeah, that's right. I think that one of the things going on there is that we have seen a recovery in Eastern Europe, in particular, and the recovery has been quite sharp relative to other emerging markets like in Asia, which have been going through actually quite a prolonged boom phase in the last five years, whereas obviously, with places like Russia, potentially Greece, Hungary, those places have gone through a bit of a recession and problems and now are recovering and that's where we think we are going to get the best dividend growth.

Wall: It's quite interesting because I suppose developed market investors are looking at Europe and thinking, gosh, there is a whole host of problems there, but for an emerging market investor, you are seeing dividend opportunities.

Lam: That's right. There are definitely opportunities and when the developed markets companies are retreating from Eastern Europe, so actually, if you look at the banking sector, really a good example of this is, is that we own a bank in Hungary called OTP Bank and it is a domestic Hungarian bank that's very well-capitalised, competing against UniCredit, Erste Bank, Raiffeisen and whole list of other developed market banks that are retreating from Eastern Europe and don't have enough capital. And so it has a very strong competitive advantage.

Wall: People are worried about European banks. You have 35% in financials across the fund. What makes these banks different to the ones that we're worried about in Europe?

Lam: Again, it's interesting that we are also conscious of having so much in financials. Interestingly, if you look at our historical performance, it actually indicates that we should have had more in financials, particularly over the last 12 months or so recovery in emerging markets that we've had.

What makes it different is that the banks that we own in emerging markets are almost all overcapitalised, and then most of them have been through a large period of retrenchment already. So, instead of rising non-performing loans, in many cases and most of the cases where we own banks, non-performing loans are actually falling and we may or may not have started a new loan cycle. So, there is a lot of risk or there has been a lot of risk within the system, but we think things are actually looking better going forward.

Wall: And is that because emerging market banks took their medicine sooner or is it because perhaps they were more nascent than some of these global players and, therefore, it didn't have as bigger problems in the first place?

Lam: Both. So, if you take an example that I already mentioned, OTP Bank, it went through five years' worth of restructuring after the financial crisis. That is in contrast to some other Asian banks that went through five years after the financial crisis of expanding their balance sheets. So, there are different cases, yeah.

Wall: If we look then at some of these financials that you own aside from the one you mentioned, quite interestingly perhaps for emerging market fund is you own HSBC (HSBA), which, of course is listed in London and I had some interesting results last week. Why do you continue to feel as an income investor that HSBC has a place in your portfolio?

Lam: Again, if you look at its competitive position globally, it's one of the two best capitalized banks globally. So, it and JPMorgan. Then we look – we're looking at it also from an Asian perspective. And within the context of the China, Hong Kong, kind of business access, we also think it's one of the strongest banks to compete for business in China. If you compare it to domestic Chinese banks, it is again very well-capitalized. The brand is very strong.

It's a safe bank or well-known as a safe bank, and we do have concerns over the Chinese banking system. And if there is a crisis and it isn't if, but HSBC would benefit from that sort of problem because there is flight to quality. So, just as you saw when you had the problems with Northern Rock, then actually it was – HSBC was one of the beneficiaries in the U.K. but also nationwide and some other so-called safe havens.

Wall: Ed, thank you very much.

Lam: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
MI Somerset Emerg Mkts Div Gr A Acc187.70 GBP-0.86Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar