I have long predicted pedestrian growth in western economies as governments and consumers par down excessive debts – as regular readers know. One consequence is that investors will scour the world for growth and income. Given that deflation will be the predominant concern in the shorter term, good quality income equities will do well relatively. But another reason to invest in emerging and far eastern markets is the 'kicker' one can expect from gaining exposure to their strengthening currencies.
The income story
Historically, investors seeking income have sought the safety of home shores – helped by a reasonable choice of decent-yielding blue-chip equities. This approach remains valid – as illustrated by holdings in both portfolios. But the traditional view that western equities were safe and emerging ones risky has been increasingly challenged of late. Recent events, such as the slashing of dividends by the banks and BP, are encouraging investors to increasingly look overseas for income.
Other factors are at play. As mentioned in previous columns, the volatility shown by western markets in general, particularly in the wake of the eurozone crisis, has often exceeded that exhibited by their emerging counterparts. Lower debts, safer currencies and at times more secure governments, have all played their part. Indeed, nearly all emerging markets are low debt economies: this makes for greater stability in rough waters. This is encouraging a rethink when it comes to asset allocation.
This rethink is being made easier by the companies themselves. More and more overseas companies, particularly in emerging markets, are tidying up their act when it comes to shareholder accountability. There has been a gradual improvement in corporate governance since the low point of the Asian crisis.
There is presently a sea-change occurring in corporate thinking across emerging markets as to the importance of sustainable dividends to long-term investors. Many of these once newcomers have become large multinational companies, and want to be regarded as such. This is important when it comes to accessing capital markets. Paying a dividend is rightly seen as one of the rites of passage. This has also been encouraged by the growth of Asian pension funds hungry for income.
Dividends here have therefore been rising at a much faster rate when compared with western markets. Accordingly, there is now a much wider choice for income investors. Some estimates suggest that as much as one-third of all global equities yielding more than 4 per cent now originate in Asia. Investors are spoilt when it comes to opportunities.
The currency factor
But there is another good reason to invest in emerging markets generally: to gain exposure to their currencies. Partly because of lower debts, their currency volatility has declined in recent years and this has attracted investors. Given the quantitative easing (QE) increasingly practised by western governments, it is therefore no surprise these emerging market currencies have tended to strengthen against their western counterparts. Sterling-based investors have benefited.
Looking forward, this trend is set to continue. The QE largely practised by western governments is part of a wider plan to try and create an element of inflation and so help erode at least some government debt. The jury is out as to whether this dark art will be successfully practiced without creating an inflationary spiral. Market volatility will be one consequence. Another will be continued sterling weakness relative to emerging currencies.
I have therefore added Schroder Oriental Income trust (SOI) to the Growth portfolio. Although standing at a small premium to assets, in line with its long-term average, it has a superb track record and yields 3.8 per cent. Meanwhile, I have sold Templeton Emerging Markets trust (TEM) in the Income portfolio after a strong run, and introduced the iShares Dow Jones Emerging Markets Select Dividend ETF (SEDY). This aims to capture the performance of emerging markets dividend paying companies that can sustain an appropriate dividend programme over time. It yields around 7.5 per cent.
At the same time, both portfolios have taken up their entitlements to the HICL offering, funded by top-slicing both holdings. Other minor changes include the further top-slicing of both portfolios' holding of the gold ETF (LUBL) – greater market certainty has returned for the time being. The proceeds have helped to fund a further purchase of Murray Income trust (MUT) in the Income portfolio.
Finally, I have taken profits in City Natural Resources trust (CYN) and Standard Life Property Income trust (SLI) in the Growth portfolio. The proceeds have helped fund adding further to the existing holding of Baillie Gifford Shin Nippon Trust (BGS) and the introduction of The Biotech Growth trust (BIOG) – for reasons I will explain in my next column.
INVESTMENT TRUST PORTFOLIOS
|Portfolio Performance Jan 2009-Mar 2012||Growth||Income|
|Portfolio Total Return [%]||64.7||56.5|
|APCIMS Total Return [%]||40.4||35.4|
|Relative Performance [%]||24.3||21.1|
Holdings are rounded to the nearest 0.5 per cent
Both Portfolio 'calls' (relative to appropriate benchmarks):
1) Underweight gilts – bias towards corporate bonds
2) Overweight overseas equities – bias towards emerging markets/far east
3) Both portfolios are overweight gold, commodities, healthcare, technology, infrastructure and smaller companies.
Read previous articles by John Baron.