Concern over scope for income funds

The surge in emerging market equity income launches last week has prompted concern as small country holdings in the funds remain high and demand for hedging out emerging market currency risk remains low.

Opportunities in emerging market stocks with an attractive yield are limited. The most compelling are usually concentrated in a few countries and sectors. Managers run the risk of skewing their funds towards single countries or sectors, limiting diversification.

The UBS Emerging Markets Equity Income fund, to be launched next week, is one of the latest in a line of products available to British retail investors. (article continues below)

During the planning stages of the fund UBS considered offering a hedged share class, but dropped the idea after it became obvious that investors strongly prefer unhedged exposure to emerging markets. This is mainly because of the prevailing assumption that emerging markets currencies are more attractive overall, although emerging market nations such as Brazil have warned of a bubble in their currencies.

The UBS fund will be launched with one third of its portfolio invested in Taiwan, nearly three times the proportion in the MSCI Emerging Markets index. Projit Chatterjee, a co-manager of the portfolio, insists this is not just a country bet. He says that there are many high-yielding com­panies in Taiwan and the heavy weighting is the result of stock decisions, mainly within the technology and telecommunication sectors.

The JP Morgan Global Emerging Markets Income trust, launched last summer, held its largest country weighting in Taiwan in December, at 16.3%.

Another large weighting in the JP Morgan fund is South Africa, at 10.5%. Richard Titherington, the manager, says South African companies are becoming more sophisticated in their corporate governance and increasingly investor friendly.

Edward Lam, the manager of the PFS Somerset Emerging Markets Dividend Growth fund, is equally bullish on South Africa, where 16% of his portfolio is invested.
After the fund’s launch last year, Lam temporarily increased the weighting to South Africa to 19%.

Lam says he would have been comfortable investing much more than 20% in South Africa, but was restricted by the fund’s mandate, which limits both country and sector exposure.