Navigating Volatility with Dividend Payers
Seafarer Overseas Growth and Income Fund
Author: Ticker Magazine
Last Update: Dec 05, 12:50 PM EST
|Emerging markets may seem quite attractive for growth-oriented strategies, but this segment also suffers from internal and external volatility at times. Inbok Song, co-portfolio manager of the Seafarer Overseas Growth and Income Fund, explains how companies with a track record of free cash flow and dividend help investors generate more steady returns in addition to tapping into growth opportunities.
“Although most people think of emerging markets simply as growth, our approach uses dividends as current income to mitigate the volatility inherent in emerging markets.”
Q: How do you construct the portfolio?
The emerging markets space is exceptionally broad and deals with a wide variety of politics, policies, and stages of economic development. Our approach to addressing geography isn’t much swayed by these near-term factors, but focuses instead on finding good companies within a country.
For us, the goal of construction is to improve the portfolio every day. We continuously research new and better replacement ideas, yet still have fairly low turnover as a long-term investor. Though the stated turnover range is 10% to 50%, the fund tends to be toward the lower end of that.
We also emphasize portfolio diversification when we pick stocks. Diversification is critical to us, and is implemented across the portfolio by country, sector, liquidity, company size, and currency. In our search for new and better replacements, we consider each of these five aspects of diversification. A new idea might replace one from a different country or sector, and it doesn’t have to be in the same currency or have similar liquidity or market capitalization.
Even though we run a relatively concentrated portfolio, our diversification remains quite good. Typically, the fund has 40 to 60 holdings with an average allocation of about 2% to 2.5%, though should our conviction grow over time, allocation may increase to 3% to 5%.
Q: What do you look for in terms of dividends?
What we value are the companies that pay current dividends and have a history of growing them by growing net income or cash flow. By paying now, they assure us that their free cash flow is real. By having steady and growing dividend, it is good evidence that management or the control parties consider minority shareholders’ interest.
Ultimately, dividends are a capital allocation decision that can be linked to corporate governance. In discussions with management, we try to figure out how they view their dividend policy based on their cash flow generation, and look for companies that are improving in this sense.
Q: What does risk mean to you? How do you manage risk at the company level and at the portfolio level?
Risk management is embedded in everything we do from idea generation to portfolio construction. Ultimately, what we want to do is to provide some kind of a shelter from the volatility in emerging markets and deliver longevity to our shareholders – longevity in the stocks we pick as well as longevity of the portfolio across the business cycle.
When picking stocks, we look for those that have had a good track record through at least one entire business cycle, which shows us they have the experience to make it through more challenging periods. Although not a guarantee, a track record is tangible evidence that a company is more likely to continue succeeding. After investing in a company, we closely monitor its financial health through a number of metrics.
At the portfolio level, our risk management focuses on two key elements: liquidity and currencies. The need to manage liquidity risk was manifested in the recent financial crisis; having liquidity is extremely important during periods of significant market stress and is a key part of portfolio construction.
As investors in emerging markets, managing currency risk is also crucial. Even though we don’t hedge, it’s important that we understand the macro factors affecting the markets where the fund is invested.
1 2 More: Mutual Funds Archive