Closed-ended structures can be a more appropriate way of accessing volatile and less liquid markets, writes Richard Titherington, manager of the J.P. Morgan Global Emerging Markets Income trust.
With yields on bonds and cash still stuck at historically low levels, investors are increasingly turning to equities to fulfil their income requirements.
Investors in search of growth have long seen the attractions of an allocation to emerging markets. While economic growth and stock market performance do not always go hand in hand, the attractive combination in many emerging markets of a healthy export-driven manufacturing base and increasing domestic consumption from a growing middle class has translated into a benign backdrop for companies that do business in these areas. Increasingly, though, investors are also using emerging markets to access income opportunities.
The case for emerging markets income is part of a broader ‘mainstreaming’ of emerging market equity investment. No longer seen as a ‘punt’, an allocation to emerging markets is now quite standard fare for private and institutional investors alike.
Income has become a significant part of the return from emerging market equities over the past decade, as corporate governance has improved and companies have focused more on shareholder value.
Taking an income approach helps to lower the volatility of the asset class – so although the broader market may beat the returns from an income strategy in times of investor euphoria, the downside is limited in the bad times.
This is because the companies that pay dividends tend to exhibit more stable, less volatile returns over time. In the global financial crisis of 2008, earnings per share for emerging market companies fell by half, but dividends were down only 20%, meaning income stocks outperformed significantly.
As in other markets, the universe of emerging markets income stocks falls broadly into three camps.
These are the ‘bread and butter’ of an emerging markets income portfolio. There are around 300 stocks that currently yield about 4%, or one-third more than the MSCI Emerging Markets index as a whole, but that have price/earnings ratios in line with the index average at about 10x, and also have similar earnings growth to the average company.
These stocks yield about the same as the overall index but have potential to grow their dividends by as much as 20% a year. They are also likely to have greater potential for capital appreciation than some other stocks.
These are split into two broad categories – those which have high yields but little capital growth potential, such as utilities and fixed-line telecoms, and those that have high yields because their prospects are lowly rated by the market. These currently include commodities stocks and out-of-favour industrials.
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