~ by Snehasish Chaudhuri, MBA (Finance)
Templeton Emerging Markets Income Fund (TEI) is a closed-ended fixed income mutual fund that primarily invests in bonds issued by sovereign or sovereign-related entities in the emerging markets (EMs). Most of these securities generate higher return than US bonds. However, these bonds are also riskier, and there are chances of default. If an EM bond fund is able to invest in sovereign bonds with investment grade ratings, only then can it get the benefits of both high return and low risk. The fund generated trailing twelve months (TTM’) yield of 13.5 percent, and pays monthly payout. However, the total return is quite poor. At present TEI is available at a good discount. I’ll analyze this fund with the help of my “7 Factor Model for Evaluating Emerging Market Funds” in order to comprehend its investability.
Templeton Emerging Markets Income Fund is Geographically Diversified
Templeton Emerging Markets Income Fund is launched by Franklin Resources, Inc. and is managed by Franklin Advisers, Inc. TEI invests primarily in a portfolio of sovereign or sovereign-related entities and aims to generate high dividend pay-out while capital appreciation becomes secondary. 46 percent bonds are of investment grade and 73 percent bonds are rated BB and above. With an average credit rating of BB+ the overall risk of this portfolio can be termed as moderate. Weighted average maturity of the entire portfolio is 7.5 years. The fund benchmarks the performance of its portfolio against the J.P. Morgan Emerging Markets Bond Index.
I prefer emerging market funds investing in 15 most credible and large economies among all the EMs spread globally. These 15 EMs are projected to have a nominal GDP in excess of $400 billion by 2025, credit rating of at least BBB- by S&P or Baa3 by Moody’s, and ranked relatively lower in ‘Fragile State Index 2022’. My list encompasses China, India, Taiwan, South Korea, Indonesia, Malaysia, Philippines, Thailand, Singapore, Hong Kong, Saudi Arabia, United Arab Emirates, Israel, Poland, and Mexico. I find that Templeton Emerging Markets Income Fund has invested 55 percent of its assets in credible economies, including the investments in US, Peru and Oman.
The US is a developed market, while Peru and Oman are equally credible economies with a relatively lower gross domestic product (GDP’). I won’t rate the quality of investments as top rated, but I am not discouraged by this diversification. At least I don’t find this fund investing much within my list of avoidable and less credible EMs.
Templeton Emerging Markets Income Fund has Exposure in Strong Currencies
Though investments of Templeton Emerging Markets Income Fund are spread among EMs across the globe, more than 80 percent of its exposure are in strong currencies mostly from emerging markets – Chinese Renminbi (RMB), Indian Rupee (INR), Brazilian Real (BRL), Indonesian Rupiah (IDR), Thai Baht (THB), Malaysian Ringgit (MYR), Peruvian Nuevo Sol (PEN), Uzbek Som (UZS), and Canadian Dollar (CAD). During the 12 months ending October 2022, the US Dollar (USD) appreciated 3.9 percent against UZS, 8.7 percent against IDR, 9.6 percent against INR, 10.2 percent against CAD, 12 percent against RMB, 12.7 percent against MYR, and 13 percent against THB. On the other hand, the dollar depreciated almost 1 percent against PEN and 5 percent against BRL. One can obviously think, how do these currencies become strong currencies, instead of currencies of Angola, Armenia, Syria, and Russia, against whom the dollar has depreciated between 13 to 25 percent during the same period?
In my opinion, an appreciation may not necessarily mean that the economy is growing or the currency is risk free. The Russian Ruble (RUB) has appreciated 13.3 percent not because its economy is booming. High oil & gas prices, a fall in Russian imports and credit controls that prevented Russians from buying foreign currency – made this appreciation possible. The country is also trading directly in domestic currencies of other countries instead of dollars. The economic sanctions over Russia have appreciated RUB for the time being. However, all this is not sustainable, as lack of exports, falling price and demand of Russian gas & oil, will lead towards a long-term recession or financial crisis. This will ultimately reduce the value of their currency in the long run. An appreciating ruble has also resulted in 27 percent loss of oil revenues, apart from the loss due to discounts offered to Chinese and Indian buyers.
USD depreciated 24.5 percent against Angolan kwanza (AOA) due to booming oil prices, which accounts for 90 percent of Angola’s export revenue. As the oil prices are coming down, AOA is losing strength, and the dollar has appreciated almost 5 percent between August to October 2022. The Syrian economy, crippled by decade-long war, has become heavily dollarised, as Syrians are trying to protect themselves against inflation and currency depreciation. The collapse of the Syrian Pound (SYP) has resulted in high inflation and hardship as Syrians struggle to buy their livelihood. Armenian Dram (AMD’) was boosted by rising oil prices, trades with Russia, and shifting bases by IT companies from Russia to Armenia.
On the other hand, the USD has strengthened against most currencies of G20 economies, and also against the highly traded currencies. It appreciated 18 percent against Euro (EUR), 21 percent against British Pound (BP’), 24 percent against New Zealand dollar (NZL), 26 percent against South Korean WON (WON’), and 30 percent against Japanese Yen (YEN). In that sense, the currencies that Templeton Emerging Markets Income Fund is exposed to, have successfully been able to hold their strength. A reasonable depreciation against the USD also means that the investable amount of US investors increases, despite spending the same amount of dollars. So, the fund will be able to make more investments with the existing assets. This obviously makes this fund attractive.
TEI’s Total Return Has Been Quite Poor, Despite a Strong Yield
Templeton Emerging Markets Income Fund was formed on September 23, 1993 and used to pay quarterly dividends. From June, 2018 TEI has been paying monthly dividends. The yield during the last five years ranged between 8 to 13 percent, and it generated a trailing twelve months (TTM’) yield of 13.5 percent. Annual average yield stood at 9.35 percent. However, despite such strong yield, the total return is quite low. It generated an average annual total return of 2.88 percent during 2016 to 2020, and since 2012, the annual average return is negative 0.7 percent. The fund has an expense ratio of 1.22 percent and the weighted average coupon stands at 5.27 percent. Considering all these, I feel it’ll be difficult to generate a strong total return in the near future, and a yield within the range of 8 to 13 percent too, doesn’t seem to be sustainable.
I analyze the investability of EM funds by evaluating the seven most critical factors for such funds – stock price performance, AUM, annual average yield, level of portfolio diversification, average credit rating, current discount to NAV and future sustainability of its yield. Templeton Emerging Markets Income Fund has a yield higher than 5 percent, and market price higher than $5, but AUM is a bit lower at $240 million. The stock is currently trading at a good discount of 6.9 percent. However, over the long run, its price performance has been quite poor, and resulted in negative total return despite a strong yield. Due to high expense ratio and a coupon much lower than the current level of yield, the yield doesn’t seem to be sustainable. But, even a lower level of yield will be good enough for TEI’s investors. Backed by a weighted average coupon of 5.27 percent, expecting a decent yield over the long term doesn’t seem unrealistic.
Currency exposure of Templeton Emerging Markets Income Fund is impressive. Most currencies stood their ground while the dollar got appreciated against most credible and traded currencies throughout the globe. The fund is well diversified globally, and its selection of EMs cannot be considered bad. 46 percent of its assets are invested in most credible EMs, and another 45 percent is invested in 8 other large and medium sized EMs with lower credit ratings, but not fragile economies, such as Brazil, Colombia, Costa Rica, Dominican Republic, Ecuador, Egypt, South Africa, and Uzbekistan. So, overall the portfolio has a moderate risk, which is also characterized by its weighted average credit rating of BB+. Thus, I don’t think liquidating stakes in TEI will be a wise idea. Moreover, appreciation of the dollar has enabled this fund to invest more in bonds in the targeted currencies. I would rate TEI as a Hold.
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