When you think about the emerging markets, you generally think high risk, volatile investments. Typically, that’s the case, but the Redwood Emerging Markets Dividend Fund is a fund that may get you to rethink that.
What makes this fund so different is the fact that it focuses on dividend paying companies in the emerging markets that have the potential to not only maintain, but also grow their dividends. With this focus, you get a portfolio of higher quality companies and a less volatile return stream than more traditional EM funds.
To find these companies, manager Edward Lam and the analysts at Somerset Capital Management use a disciplined, bottom up process that starts with a series of screens designed to identify financially sound companies that meet certain market cap and liquidity requirements. They then do a detailed fundamental overview of the company including meeting with management, analyzing financial statements, and determining their estimate of fair value. Before any name can be added to the fund, it must be vetted by the entire team, and risks must be identified and measured, including currency, economic, political and liquidity risks.
The portfolio is fairly well diversified, holding around 50 names, with the top ten making up about 36% of the fund. Typical position sizes will be between 2% and 3%. Ideally, sector weights are kept below 20%, and there can be no more than 20% invested in any country. They can invest in companies of any size, and at the end of January, had about 50% in large cap names, with the rest in small and mid-caps.
The portfolio is much different than the index, with significant exposure to financials, technology, and consumer names. Combined, these three sectors make up nearly three quarters of the fund. Cash is typically capped at a maximum of 10% of the fund, but recently has been higher than that. According to management, this has been because they are a little hesitant to invest the cash balance at the moment given the valuation picture and near term outlook. They would rather hold a higher cash balance and wait for a more opportune time to invest.
They take a longer term view in their analysis, which helps explain why portfolio turnover has averaged less than 50% for the past three years.
Performance, on an absolute basis has been middle of the pack. For the three years ending March 31, it gained an annualized 8.6%, compared with 9% for the MSCI Emerging Markets Index. However, as expected from a dividend mandate, volatility has been much lower than the index and peer group. It has also done an excellent job at protecting capital in down markets. A drawback to this approach is that it is very likely to lag in a rising market. That’s happened so far this year, with the fund gaining 9.7% while the index is up nearly 12%.
Another drawback is its cost. It carries a management fee of 2.50%, plus there is the potential for the manager to be paid a performance fee based on their performance against the benchmark. The most recent MER is listed at 3.42%, which is well above the category average of 2.79%.
I see this fund as a good way to gain exposure to the emerging markets without taking on as much volatility risk. But you will pay for it with a higher MER and lower upside participation. If this is something you’re comfortable with, this is an interesting fund to consider. However, if you are looking for higher upside potential, you’ll want to look at one of the more traditional emerging market funds available.