AEF: EM Fund Investing In The Right Markets & Right Sectors

~ by Snehasish Chaudhuri, MBA (Finance)

Aberdeen Emerging Markets Equity Income Fund, Inc. (NYSE:AEF) is an exchange traded fund (‘ETF’) that invests in public equity markets of some of the more attractive emerging markets (‘EM’) around the globe. Almost 65 percent of the entire portfolio is invested in five markets – China, Hong Kong, India, Taiwan, and South Korea. The fund pays quarterly dividends and has a yield of almost 10 percent. The dividend seems sustainable, due to its selection of growth stocks that have strong future potential. In addition, the fund also invests in EMs that are less risky. I tested my “7 Factor Model for Evaluating Emerging Market Funds” on AEF and found that this fund is quite attractive. Historically, the fund generated decent total return for its investors. The fund is trading at a 13.5 percent discount to its net asset value (‘NAV’). The fund has selected the right emerging economies and invested in the right sectors. A detailed discussion will make it clear how AEF performed in those seven most critical parameters.

AEF Understands the Dynamics, and Inherent Risks of Emerging Markets

Emerging market funds in general offer strong dividends as well as scope of capital appreciation. This happens primarily because stocks in the emerging markets have higher growth potential. As the sovereign bonds in those markets offer higher yield, the required rate of return for investors is also high in equity shares. However, we cannot put all the emerging markets in the same bracket. Also, investing in economies only with considerable nominal gross domestic product (nominal GDP) makes sense, as very small markets suffer from uncertainties, and don’t have the capacity to grow beyond a point. I have thus considered economies with 2027 forecasted GDP in excess of $100 billion.

First group of EMs are relatively smaller in size (2027 forecasted nominal GDP between $100 billion and $400 billion), have lower credit ratings (lower than B by S&P), and ranked highly fragile in the ‘Fragile State Index 2022’. These economies are often going through some kind of financial crisis. Thus, it’s better to avoid investing in markets like Pakistan, Iraq, Ethiopia, Angola, Kenya, Ivory Coast, Venezuela, Democratic Republic of the Congo, etc. The second group of EMs are smaller in size and have a low credit rating, same as the first group, but they rank much lower in the ‘Fragile State Index 2022’. Thus, investment in such markets attracts high risk, and is not desirable. However, investors can invest with proper research and knowledge. Columbia, Algeria, Ukraine, Ecuador, Morocco, Dominican Republic, Guatemala, Belarus, Turkmenistan, Tanzania, Puerto Rico and Uzbekistan are included in this group.

The third group of countries are similar to the second group, but are relatively larger in size. All these markets are estimated (by the IMF) to have a nominal GDP in excess of $400 billion by 2027, and their sovereign bonds are rated lower than BBB- by S&P or Baa3 by Moody’s. These countries include Brazil, Russia, Iran, Argentina, Turkey, Nigeria, Egypt, Bangladesh, South Africa, and Vietnam. Investments can be done in such markets, if the return is lucrative. Fourth group of countries are less risky (rated at least BBB-) than all the above economies, are good markets to invest in, but have relatively small economies, and are not part of G20. Examples of such economies are Chile, Romania, Peru, Kazakhstan, Qatar, Hungary, Kuwait, Oman, Bulgaria, and Panama. These emerging markets are in a position to deliver high and stable returns.

The final group of countries are the cynosure of investors – some of them G20 economies, having large GDP, long term growth potential, and relatively less risk. In my opinion, these are the top 15 emerging markets by size (nominal GDP) which have low risk and high growth potential – China, India, South Korea, Mexico, Indonesia, Saudi Arabia, Taiwan, Poland, Thailand, Israel, United Arab Emirates, Malaysia, Singapore, Hong Kong and Philippines. All these markets are estimated (by IMF) to have a nominal GDP in excess of $400 billion by 2025, and their sovereign bonds are rated at least BBB- by S&P or Baa3 by Moody’s. I personally prefer emerging market funds to invest in these 15 markets. I find Aberdeen Emerging Markets Equity Income Fund exactly doing the same. It invested more than 80 percent of its assets in these markets.

Portfolio of Aberdeen Emerging Markets Equity Income Fund is Impressive

Emerging markets generally have high growth potential. In most growing economies, three sectors derive the maximum benefits – Financial industry, Information and communication technology (ICT), and consumer cyclical industry. Compared to developed or underdeveloped economies, these sectors witness higher growth in emerging markets. When an economy enters a sustained high growth phase, citizens spend more on luxuries. As a result the consumer cyclical and financial sectors enjoy high growth. In today’s era of knowledge economy, economic growth is generally fuelled by the growth in the ICT sector and supported by the financial sector. I find that Aberdeen Emerging Markets Equity Income Fund has invested almost 70 percent of its assets in these three sectors. This, in addition to targeting the best EMs, the fund has also gone for the right sectors.

Almost 65 percent of the entire portfolio is invested in five markets – China, Hong Kong, India, Taiwan, and South Korea. The fund has invested only in 74 stocks, and the stocks included in its portfolio are among the best performing in that particular market. The fund also has invested in one or two selected sectors in a particular market that it believes to have the maximum growth potential. For example, while investing in Taiwan, it targeted technology enterprises, primarily semiconductors companies such as Delta Electronics, Inc. (2308.TW), Taiwan Semiconductor Manufacturing Company Limited (2330.TW), Hon Hai Precision Industry Co., Ltd. (2317.TW), and Chroma ATE Inc. (2360.TW), and in South Korea the fund has invested in industrial giants Samsung Electronics Co., Ltd. (005930.KS), Samsung Engineering Co., Ltd. (028050.KS) and LG Chem, Ltd. (051910.KS).

In the Indian market, it has primarily opted for stocks primarily from three sectors – technology, infrastructure and financial sector. In invested around 14 percent of its entire fund in 9 companies – Infosys Limited (INFY.NS), Tata Consultancy Services Limited (TCS.NS), Info Edge (India) Limited (NAUKRI.NS), Power Grid Corporation of India Limited (POWERGRID.NS), UltraTech Cement Limited (ULTRACEMCO.NS), Godrej Properties Limited (GODREJPROP.NS), Housing Development Finance Corporation Limited (HDFC.NS), SBI Life Insurance Company Limited (SBILIFE.NS), and Kotak Mahindra Bank Limited (KOTAKBANK.NS).

In Chinese and Hong Kong markets however, the fund has invested in diversified industries, although more emphasis has been given on technology companies, AEF invested almost 35 percent of its entire assets under management (AUM’). Tencent Holdings Limited (0700.HK), Alibaba Group Holding Limited (9988.HK), JD.com, Inc. (9618.HK), China Resources Land Limited (1109.HK), China Merchants Bank Co., Ltd. (3968.HK), AIA Group Limited (1299.HK), Kweichow Moutai Co., Ltd. (600519.SS), LONGi Green Energy Technology Co., Ltd. (601012.SS), NARI Technology Co., Ltd. (600406.SS), Shenzhen Mindray Bio-Medical Electronics Co., Ltd. (300760.SZ), are 10 such stocks in which the fund has invested a significant proportion of its assets -almost one-sixth of its entire fund.

My 7 Factor Model for Evaluating Emerging Market Funds’ Rates AEF Attractive

Aberdeen Emerging Markets Equity Income Fund has been paying quarterly dividends since 2009. The annual average yield has been mostly in double digits. Annual average yield since 2012 has been 10.5 percent and trailing twelve months (TTM’) yield is 10.02 percent. In my opinion, AEF’s portfolio is comparatively less risky, due to its selection of the right emerging markets, with large and credible economies, and the right sectors, with high growth potential in a growing economy. Lower risk and potential growth of equities in those selected EMs is expected to sustain the current level of yield.

AEF also qualifies for the minimum requirements with respect to yield of 5 percent, and stock price of $5. However, the AUM is a bit lower at $300 million. The fund is also trading at a significant discount to its NAV. The only major drawback comes in the form of its recent price performance in the past two years, which has been the case with every emerging market fund. However, if we overlook the performance over the past two years, AEF generated 17.3 percent annual average total return between 2016 and 2020. Thus, overall, this fund is quite lucrative, especially for income-seeking investors. I am thus bullish about Aberdeen Emerging Markets Equity Income Fund.