JPM's EM income trust hit by 'fragile five' exposure

Sterling strengthened against emerging markets currencies over the six months to 31 January, which adversely affected performance. Performance was also impacted by the trust's allocation of nearly a third to countries whose current account deficits are vulnerable to monetary policies, known as the 'fragile five', whose currencies weakened. These are Brazil, India, South Africa, Turkey and Indonesia.

The investments in South Africa and Turkey were significant detractors from performance, though the trust's managers bought shares in Arcelik during the period because they think the investment case remains robust while its shares have fallen on general concerns about Turkey. Arcelik manufactures and exports white goods, and should benefit from the weakness of the Lira.

The trust's overweight exposure to South Africa has been reduced and its holding in Kumba Iron Ore sold following failure to deliver on its strategy. "The fund's allocation to South Africa was particularly disappointing as even stocks that should have benefited from the weakness in the rand failed to do so due to operational problems," comment analysts at Winterflood.

The trust has also sold down companies which could be viewed as bond proxies, examples being Energias do Brasil, AES Tiete and Philippines Long Distance Telecom. Its managers want to focus on dividend growth stocks.

Companies with good dividend growth represent around 80 per cent of the portfolio, while the remaining 20 per cent is invested in high yielding stocks.

Underweight exposure to South Korea, a country with a current account surplus, also detracted from performance. This currently accounts for 5.6 per cent of the portfolio against 16.2 per cent for the benchmark. The trust doesn't have much in South Korea because there are not many shares with good yields listed there.

Stock selection exacerbated poor performance, as many of the companies with strong dividend paying characteristics that the portfolio targets are found in the fragile five.

The trust's managers, Richard Titherington and Omar Negyal, say that although payout ratios have remained constant, dividends have come under pressure from reduced corporate earnings. Weaker emerging market currencies meant the trust has received lower levels of dividends in sterling terms. However, only Asian real estate company Midland failed to pay an anticipated interim dividend and so was sold.

The trust also warns that there is a risk that the dividends it receives, some of which come in emerging markets currencies, will continue to be reduced in value because of the weakness of these against Sterling. And its managers add that "the resumption of sustained emerging markets performance requires a recovery in earnings, which remains elusive. Multiple waves of currency weakness and central bank tightening measures in recent months have not helped, dampening expectations for profits further."

But analysts at Winterflood point out that the trust has built up a revenue reserve, which could be used to mitigate the impact if necessary, while for the six months to 31 January the trust is paying dividends of 2p a share, a rise on the 1.8p it paid in the equivalent period last year.

JPMorgan Global Emerging Markets Income currently has a 12-month yield of 4.5 per cent.

Its managers maintain that "the long-term dividend story for emerging markets remains intact, along with the expectation that the growing dividend culture amongst companies [there] will continue. There may continue to be periods of turbulence in these markets in the shorter term but we highlight that, on a longer-term basis, emerging markets look cheap relative to other equity markets."

Despite these recent difficulties the trust still trades on a premium to net asset value (NAV) of 2.4 per cent, in contrast to its 12 month average of 1.77 per cent. Analysts at broker Killik prefer another IC Top 100 Fund, Utilico Emerging Markets (UEM), which trades on a 6.8 per cent discount to NAV, yields 3.4 per cent and has lower exposure to the fragile five.

But analysts at Winterflood highlight JPMorgan Global Emerging Markets Income's attractive yield, focus on shares which grow dividends, and outperformance of both its benchmark and investment trust sector with lower volatility since launch in 2010. They reported in March that since launch the trust's NAV has increased by 23 per cent on a total return basis compared with 0 per cent for its benchmark MSCI Emerging Markets index.

"JPMorgan Global Emerging Markets Income provides investors with exposure to a portfolio with an emphasis on stable growth sectors and underweight positioning in more cyclical sectors such as materials," they say. "This approach enables the fund to capture the growth in emerging markets whilst providing lower volatility exposure. Emerging markets valuations appear to be low by historical standards, however, with the current uncertainty surrounding these it is certainly possible that they could become cheaper in the short term. Nevertheless, for longer-term investors we believe the outlook remains positive and that this trust provides exposure to a high growth asset class combined with an attractive yield."

Source: Morningstar

Source: Morningstar as at 28 March 2014

TOP TEN HOLDINGS as at 28 February 2014

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