Somerset Capital Management was launched in 2007 to focus on dividend-paying companies in the emerging world, where high rewards come with risks attached. Shaun Cumming reports.
British-based dividend funds have traditionally displayed a marked domestic bias. Recently, however, the number of products targeting dividend-paying firms in other countries have grown in number.
Somerset Capital Management, a boutique operation launched in 2007, began with the aim of introducing a new type of fund to the market. In March 2010, it launched the Somerset Emerging Dividend Growth fund to target companies throughout global emerging markets.
The key question is whether dividend-seeking investors, who are typically cautious in their approach, would turn to such a product in favour of the standard UK dividend funds already in the market.
Institutional managers appear ready to buy into the Somerset approach. Richard Martin, a senior manager at T Bailey, says he is taking interest in new emerging market funds with a focus on yield. “More funds are being launched in emerging markets which have a dividend focus, and this is proving to work well in this type of market,” he says. (Focus continues below)
Somerset’s founders were a group of business partners who included Jacob Rees-Mogg, the Conservative MP, Edward Robertson, and Dominic Johnson. These days Rees-Mogg has little input into the business because of the demands of his political duties.
Oliver Crawley, a founding partner and the head of European marketing, says that although Somerset is a young firm the investment team have worked together for several years.
“The entire investment team worked together in the past, so we have long-term track record performance which goes back to the 1990s. We wanted to set up a business where everyone had a stake in the firm, so a partnership structure was the best way to found the company.”
The investment team consists of nine people, two working in Singapore and the rest in London. Crawley says that because the firm is an emerging market specialist it was important to have people on the ground in Asia. But even the London team travel abroad regularly. “Aside from salaries, travel is our second biggest expense,” adds Crawley. “The team need to be in their markets all the time.”
Crawley is clear about the direction Somerset is heading, and keen to avoid mistakes he considers that competitor firms are making.
“In terms of the vision we have for the business, we want to remain a global emerging market boutique,” he says. “We think that our competitors are facing two main problems. One is that they are managing too much money. Second, they are not focused on core products. These are two mistakes we don’t want to make. We do not want loads of analysts feeding in, we are much more focused on quality and not the quantity.”
For this reason the firm places tight capacity limits on its funds. The Global Emerging Market Small Cap fund is already closed to new investment, having raised $350m (£225m), but the Emerging Dividend Growth fund is still receiving investment. The last in the line-up, the Emerging Market Large Cap fund, is also receiving funds.
Being a partnership, the Somerset team are not under external shareholder pressure to accept large inflows. “The profits remain within the business, which means our interests are aligned with clients’,” says Crawley. “We focus on transparency and encourage clients to come on visits. The thing is, we are not pocketing profits and buying sports cars. In terms of our clients, that is really important for them.”
The investment team had previously all worked together at Lloyd George Management, which was bought out by the Bank of Montreal early in 2011. “We ran the global emerging markets team at Lloyd George. Setting up the business [Somerset] was something we always wanted to do. At Lloyd George we didn’t have much in the way of ownership.
“Offering a stake in the business was also a good way of attracting the investment talent [to the firm].”
While Somerset is heavily supported with institutional money, it also targets the British retail market. Ultimately, it has a diverse client base, encompassing retail investors, stockbrokers and British pension funds. The group has also recently won some high-profile mandates. “We are beginning to raise a meaningful amount of money,” says Crawley.
“Importantly, our client turnover is less than 1%, so we have had virtually no redemptions since we started the business.”
Although the partners’ focus is to concentrate on Somerset’s core products, Crawley does not rule out the addition of new products over the longer term.
A couple of weeks before the new year the firm announced the launch of the Somerset Small Mid Cap EM All Country fund, which aims to include smaller frontier markets such as Kenya and Slovenia within its strategy.
Crawley says Somerset offers a particularly attractive price arrangement for retail investors, departing from the traditional way in which fund managers charge separately for institutional and retail investors.
“The charges on our funds are very attractive for retail investors,” he says. “What I do not like seeing is an institutional charge of 1% and a retail charge of 2%. I do not think it is fair and I do not think it is reasonable.”
Retail charges for the Somerset Emerging Dividend Growth fund could not be simpler. There is a flat charge of 1%, with no initial charge and no performance fee. Crawley adds: “I know of no other active emerging markets business with such low charges – but it is not priced so cheaply because it is no good.”
The investment team work on a rotation basis, and also have split responsibilities. This gives the more junior members the chance to acquire a good overall emerging markets background before they are given the responsibility of managing a fund outright.
Crawley says: “We split the team by region. Two people cover Latin America, three cover EMEA [Europe, the Middle East, and Africa], and four cover Asia. What we do is rotate people through the various regions because it is in our interest for managers to become global emerging market specialists. But they rotate after meaningful periods of four or five years. Nobody becomes a fund manager until they have covered all three regions.”
While each of the Somerset funds has a lead manager with specific duties, the team operates a “muck in” approach. As an example of this, Edward Lam, the lead manager of the Emerging Dividend Growth fund, also does analytical work on EMEA.
Crawley is keen to elaborate on why emerging markets offer attractive dividend opportunities. “Brazil is an interesting market, as is Chile,” he says. “In Brazil, it is mandated in law almost that every company must pay out a minimum of 25% of its net profits as dividends. In terms of the Emerging Dividend Growth fund, this is quite an attractive proposition.”
Otherwise, the fund is diversified throughout all of the emerging markets, but not as heavily involved in the Bric nations (Brazil, Russia, India, and China) as might be expected.
Although it has holdings in Brazil, a few in China and a small Russian holding, the fund has no positions in India.
According to Crawley, this is because Indian firms do not typically pay a dividend – hence the need to understand the unique business culture of each country. ” Also,” he says, “this fund buys companies with an above average yield but they need to be sustainable and they also need to be clearly positioned for growth.”
There is a diversification tactic on the fund, and Crawley says the aim is spread risk. The largest country weighting, at 13.3% of the portfolio, is in Taiwan. It also has holdings in South Africa and in north Africa, including Egypt.
But Crawley insists there are good opportunities in all these countries. Using the example of Egypt, which experienced extensive social unrest in 2011, he says that one of the firm’s analysts visited the country in the summer and heard many Egyptians commenting on the riots that were unfolding in Piccadilly in the centre of London.
South Africa is the second-largest country weighting in the Emerging Dividend Growth portfolio. The appeal of South Africa, Crawley says, is the strength of company management, which is “probably the best” in any global emerging market. He points to MTN, a South African mobile telecommunications group, as a typical holding that Somerset aims to include in the Emerging Dividend Growth fund. He says MTN has a large presence throughout Africa, with only 30% of its profits coming from South Africa itself.
“The rest is in countries such as Nigeria and Uganda, which are high growth markets,” says Crawley. “[The company] pays a 3.5% dividend, but, importantly, it is sustainable and is growing. It is more of a general Africa play, but you can see this type of firm throughout the portfolio.”
There are risks to consider when investing in emerging markets firms, a point illustrated in the Emerging Dividend Growth fund’s latest factsheet. It reports the case of China High Precision, a firm it had researched because of the company’s interesting profit margins of 33%.
China High Precision had extensive broker research coverage, buy recommendations and a clean auditor’s report from KPMG. But after researching further, Somerset declined to buy. Recently, the stock was suspended for an investigation into allegations that the company had withheld information – described by the Chinese firm as “state secret” information – from KPMG as the accountancy firm tried to conduct a secondary audit.
Nevertheless, Somerset is positive about the progress emerging nations have made.
”We think that our competitors … are managing too much money [and] … not focused on core products”
“It is our view that emerging market firms are not the high-risk play they used to be 15 or 20 years ago,” says Crawley. “High-profile frauds in emerging markets have tended to come from companies that don’t pay dividends. Actually, paying dividends is a really good health check on a company. It tells investors firstly that a firm has cash, and secondly that the management respects investors enough to pay them.”
The Emerging Dividends Growth fund does not yet have a long-term record, but its short-term performance appears strong. It is ranked third of 52 funds in its sector over one year to December 14, according to Morningstar. That the fund still lost 8.49% is a revealing indicator of how difficult 2011 was for emerging markets.
Some fund of funds managers are keen to endorse the Emerging Dividend Growth fund. Elliot Farley, a multi-manager at T Bailey, says: “We have invested [in the fund] mainly because of its focus on the dividend story. It is generating an attractive yield, but they are not all out-and-out in search of income. While the fund has an income bias, the managers are still alert to growth opportunities too. It is an attractive, pragmatic, balanced approach.”
Meanwhile, the firm sees approaching challenges. Edward Robertson, Somerset’s chief investment officer, says: “Emerging markets will face a growth challenge in 2012. The lack of structural reform across all sections of the economy and society will be laid bare.”
Somerset Capital Management is an emerging markets specialist boutique. Its core product is the Somerset Emerging Dividend Growth fund. The team manages four strategies with total assets under management of $1.2 billion (£772m).