Trust investors: Time to review your emerging market exposure

As the US market becomes more expensive, some eyes are looking further afield once more.

A lot of investors ignore global emerging markets (GEMs), which is surprising considering they account for over half the world’s population and some of the fastest-growing economies. Yes, they are risky, with arguably more scope for dramatically damaging political changes – as witnessed recently in Argentina.

In many cases their stock markets are less well regulated and less liquid than in more developed regions, and it is hard not to believe that they are more vulnerable to climate change.

Growth in numbers

Against that, their growing populations offer huge opportunities for domestically oriented companies in the financial, consumer and technology sectors, with affordable internet access still very limited in many emerging markets, and their sheer variety means there are almost always some economies that are doing well.

In the first 10 months of 2019, for instance, the MSCI Russia index was 40% up, and the MSCI Brazil 10/40 index 20% up, whereas the MSCI India index was only 5% to the good. Meanwhile, the MSCI index for China, which dominates the sector, rose around 10%, just ahead of the rise in the overall MSCI Emerging Markets index. (All figures from Numis Securities, to 28 October 2019.)

Despite their long-term potential, emerging markets have lagged most other regional sectors except the UK over the past five years, with the MSCI Emerging Markets index only 45% up compared to a gain of 82% for the MSCI World index. The latter was powered predominantly by the US,which recent research from Schroders indicates is now looking dangerously expensive relative to its 15-year average, whereas the former is looking cheap on the basis of forward, trailing and cyclically adjusted price/earnings (PE) ratios. This has prompted well-regarded asset managers such as GMO to suggest that emerging markets could prove one of the most rewarding regions in which to invest over the next seven years or so.

Which are the index leaders?

The MSCI emerging market index captures large and mid-cap firms across 26 countries. The top eight countries as at end of September:

Disappointing returns

Investment trusts should be a good way in which to invest in emerging markets, as their closed-ended status means managers are not too worried about poor liquidity. Additionally, most managers have strong supporting teams to help them pick a well-diversified portfolio – thereby mitigating the impact of shocks in any particular market. It is therefore disappointing that JPMorgan Emerging Markets (LSE:JMG) investment trust is the only one to have soundly beaten the MSCI Emerging Markets index over five years in terms of net asset value total returns.

Templeton Emerging Makets Investment trust (LSE:TEM), which is the giant of the sector, has also edged ahead of the index over that period, but this is substantially due to stellar returns in 2017 under manager Carlos Hardenberg, who has since left Franklin Templeton.

Aside from TEM, Aberdeen Emerging Markets (LSE:AEMC) came closest to beating the index. Its managers seek to identify which GEMs offer the most upside potential, then to gain exposure through third party open- and closed-ended funds. AEMC pays a quarterly dividend funded partly from capital, resulting in a current yield of 3.5%.

JPMorgan Emerging Markets has been managed by Austin Forey since 1994. He draws on advice from JPMorgan’s dedicated GEMs team of 95 multilingual portfolio managers and analysts based in eight locations around the world, and has found the expansion of the team’s Shanghai presence particularly helpful.

In recent years, he has concentrated the portfolio down to 58 holdings, with a strong emphasis on growth stocks, and established a relatively high weighting in China. It is currently around 33%, headed by large holdings in Tencent (SEHK:700) and Alibaba (NYSE:BABA).India is JMG’s second-largest exposure at a substantially overweight 21%, including longstanding stakes in Housing Development Finance and Tata Consultancy Services.

Forey seeks to invest in companies with “superior long-term prospects” and holds them “as long as possible”, which in some cases has meant over two decades. He also emphasises the importance of good ESG practices, and claims the carbon footprint of the trust’s portfolio is less than a 20th of the carbon footprint of an exchange traded fund based on the same index. JMG’s costs are the lowest in its sector, and its growth orientation means it offers a minimal dividend.

The board’s chair Sarah Arkle warns:

“After a period of extremely strong relative performance, the investment manager’s approach, focusing particularly on high-quality growth stocks, may encounter periods when it does not outperform the benchmark index as has happened in the past.”

Against that, Forey points out that emerging markets have changed radically over the past 10 years, with three of the trust’s top 10 holdings not even listed in 2009. Back then, the idea of GEM companies valued at over $500 billion – as several are now – would have seemed incredible.

“As we look forwards, we need the ability to imagine things which seem strange today; and we cannot guess in advance what opportunities may arise,” he says.

“My point is that while prudence and a sober approach to taking risks is a valuable trait for investors, this needs to be balanced by a streak of optimism.”

Investors who believe that a rotation away from high-growth stocks is imminent or already under way could continue to benefit from JPMorgan’s strong GEM team by turning to JPMorgan Global Emerging Markets (LSE:JEMI). Launched in July 2010, it put up a relatively strong showing in its first four years, but fell back more steeply than JMG in 2015; and despite a strong run in 2017 its subsequent recovery has been less impressive. This is because it is less growth-oriented, and instead its management team, headed since 2012 by Omar Negyal, looks for relatively high-yield stocks.

JEMI is less concentrated than JMG, with around 80 holdings, and its country weightings are different, with a bit less in China, much less in India, a lot more in Taiwan due to its “positive dividend culture” and more in non Asia-Pacific countries such as Brazil and Russia. Like JMG, it is overweight financials, IT and consumer staples, but the two portfolios currently have only two top 10 holdings in common: TSMC and Ping An Insurance.

Only JPM Emerging Markets has soundly beaten benchmark index over five years

Notes: Data provided by Numis Securities, to 30 October 2019. *Plus indicates premium.

No recession immunity

In mid-October its manager warned that if a recession takes hold, emerging markets will not be immune, and that if the pound strengthens, the trust’s assets and cash flow will be worth less to sterling-based investors, as will those of other overseas trusts.

On the other hand, he suggested that global emerging markets look better placed to weather a global slowdown than they were in the past, and that an income-oriented approach to investment in emerging markets can deliver a “more conservative way to participate in emerging markets growth” as well as a sustainable income stream.

Finally, investors should note that around two-thirds of the GEM universe is also covered by the Asia Pacific ex Japan trusts. The MSCI Asia Pacific (ex Japan) index is currently ahead of the MSCI Emerging Markets index over most periods up to 10 years. The majority of Asia Pacific ex Japan regional specialists have outperformed the GEM index over five years, and all are well ahead over 10 years. However, the only three with better five-year net asset value total returns than JPMorgan Emerging Markets trust are JPMorgan Asian (LSE:JAI), Schroder Asian Total Return (LSE:ATR) and Schroder AsiaPacific (LSE:SDP).

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.