Fund Focus: who survived the latest sell-off?

Even the most justified bull market can have painful setbacks and July was certainly that.

Stocks associated with the artificial intelligence (AI) trade struggled, most dramatically in the emerging markets where names like SK hynix Inc ADR (NASDAQ:SKHY) took something of a thrashing.

That translated into a punishing month for the region: South Korea’s Kospi index was off by 14.5% in sterling terms, with MSCI Taiwan down by 9.1%. The broader emerging markets index was down by around 4.5%.

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The sheer concentration of the emerging markets index, with Taiwan Semiconductor Manufacturing Co Ltd ADR (NYSE:TSM) alone accounting for more than 15%, makes it hard for active managers to avoid such sell-offs as and when they occur. 

On top of that, the stellar performance of such names ahead of July would make them hard to resist.

But some funds did hold up well in July, suggesting that they have a more defensive form of exposure to the region.

Dividend ETFs

I would normally expect an income fund to behave more defensively than its growth equivalent, although this isn’t always the case. In the UK, an income portfolio sometimes leans more into classic constituents of the FTSE 100 such as banks and energy giants, for example, and names like Temple Bar Ord (LSE:TMPL) have actually outperformed the competition.

But the premise of an income fund being more defensive has played out in Asia and the emerging markets in recent years. It was income funds that held up better in 2022, when markets generally suffered. And our glance at the performance for July also shows income portfolios having a better time.

If we look past vanilla tracker funds, some of the better performers from July tell us a few things.

There’s the iShares EM Dividend ETF USD Dist GBP (LSE:SEDY), whose focus on around 100 companies in the region with high yields has steered it heavily towards countries like Brazil and China and completely away both from Korea and the low-yielding TSMC, and which returned 5.6% in July.

Some more measured dividend ETFs sit in the list, including the Stt Strt SPDR S&P EmgMktsDivAristETF GBP (LSE:EMDV), which can only hold those high-yielding names that have increased or maintained their payouts for at least five years in a row. Around a third of this fund sits in Chinese shares. That returned roughly the same as the iShares fund, as did the Invesco FTSE Em Mkts Hi Div Low Vol ETF GBP (LSE:HDEM).

Active measures

Stock pickers have gotten in on the game too. In positive return territory over the month is the Guinness Emerging Mkts Eq Inc F GBP Dist (BYV24X3) fund, which has a yield of 3.6% and whose roughly equal weight approach to portfolio construction means it does hold TSMC, but on a low allocation.

Other names in the fund include NetEase Inc ADR (NASDAQ:NTES), Novatek Microelectronics, Coca-Cola Femsa SAB de CV ADR (NYSE:KOF) and even the UK-listed British American Tobacco (LSE:BATS).

Meanwhile, some other portfolios have held up well. In the income camp there’s BNY Mellon Asian Income Instl W Inc (B8KPW26), Schroder Oriental Income Ord (LSE:SOI), Fidelity Asian Dividend W Inc (B8W5M02) and (eking out a tiny gain) Henderson Far East Income Ord (LSE:HFEL).

The latter inspired this column after the fund’s manager appeared in our Insider Interview series and argued that the portfolio’s underperformance stemmed from a more cautious approach.

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The higher they fly

Funds that have done especially well from this region in the last year will likely have backed names like TSMC, SK Hynix and Samsung Electronics Co Ltd DR (LSE:SMSN) pretty heavily, exposing them to a big pullback in July unless they had already derisked.

That seems to check out if we look at the funds that suffered most over the course of the month. Take IFSL Marlborough Far East Growth A Acc (B0NVCN6), down by almost 20%, Fidelity Emerging Markets Ord (LSE:FEML) losing more than 11%, and the Baillie Gifford-managed Pacific Horizon Ord (LSE:PHI), off by just under 10%.

Interestingly, one dividend ETF also makes the list of shame in the form of Fidelity Emerg Mkts Qual Inc ETF USD Inc GBP (LSE:FEMD).

This franchise of ETFs (which covers other regions too) does tend to back some big growth names, and the emerging markets option had 11.5% of its portfolio in Samsung Electronics at the end of June.

…and what comes next

If July provided us with something of a reset, it’s worth noting that emerging market shares have staged a recovery so far this month. Big bounces could be likely in markets like Korea, where the popularity of leveraged single-stock ETFs will only boost volatility.

A question for anyone holding such funds – or broader portfolios exposed to such stocks like Artemis Global Income I Inc (B5N9956) or WS Blue Whale Growth I Sterling Acc (BD6PG56) – is what the managers are doing now.

Some may well be doubling down, and the Blue Whale team noted in a July performance update that they had entered the month with a cash balance of 8.5% and then put most of this into existing holdings, such as SK Hynix.

Some funds will simply double down, which gives a level of consistency. But for investors holding such funds, the July pullback might remind us to occasionally take some profits while things still look rosy.