The growth-led rebound in markets after the March sell-off proved a big obstacle for JPMorgan Emerging Markets Income (JEMI ), which has warned over depleting revenue reserves after companies cut dividends.
The £354m trust run by Omar Negyal saw its net asset value (NAV) total return slump 9.1% in the year to 31 July versus a 0.6% decline in its benchmark MSCI Emerging Markets index. Its share price fell even further over the same period, down 16% after a ‘considerable widening’ in the trust’s discount from 1% to 9%.
Negyal pointed to income investment remaining firmly out of favour in the post-March rally as a ‘significant headwind’ to performance as ‘pure growth’ stocks led the market up, and low-yield companies – such as technology – re-rated even when valuations were pushed sky-high.
Within emerging market stocks, those with a zero to low yield of 0.5% - which Negyal avoids - soared an average 25.5% over the year, while companies with a yield of 0.5% or above, which he invests in, declined 8% on average.
He said the Covid-19 induced ‘temporary style disconnect’ was mostly felt in banking stocks and the omission of some stocks from the portfolio, which were the largest drags on performance.
Not owning e-commerce giant Alibaba (9988.HK) and the world’s largest gaming company Tencent (0700.HK) were the biggest detractors – year-to-date they have risen 42% and 52%, respectively.
‘Neither stocks fits our income-driven investment criteria and their absence from our portfolio had a significant negative impact on relative performance,’ said Negyal, likening the scenario to the 2017 rally in e-commerce stocks.
Government clampdowns on banks paying dividends in the midst of the coronavirus outbreak also took away a stream of income from the trust. The biggest banking hits came from Santander Mexico (BSMXB.MX) and Russia’s largest bank Sberbank (SBER.M).
‘Covid-19 has delivered huge challenges for banking institutions – not only have they been affected by the economic downturns but, in some regions, regulators have instructed banks to pause dividends to help preserve capital,’ said Negyal.
Hungarian OTP Bank (OTPB.BU) was sold and a position in Mexico’s Banorte (GFNORTEO.MX) was reduced as the regulators in both countries asked banks to halt dividends.
Negyal added that Sberbank had committed to paying a ‘healthy albeit delayed dividend from 2019 earnings’ but overall exposure to banking was negative.
The trust has suffered a 26.5% fall in dividend income over the year but has maintained its full-year dividend at last year’s level of 5.1p per share despite not bringing in enough income to support it.
Trust chair Sarah Fromson said the decision was made this year to maintain the dividend by using revenue reserves, which is a unique feature of investment trusts that allows them to put money aside to smooth dividend payments in tough times.
However, Fromson warned there was ‘no guarantee that we will always be able to do this’ and after the fourth quarterly dividend is paid, the reserves will cover just 60% of future annual dividends at the current level.
Providing his own caution, Negyal (pictured) said the search for income ‘has become tougher’ in the wake of Covid-19. This has not stopped him looking for new opportunities, and Negyal has even found banking stocks to add to the portfolio.
He added Indonesian bank Rakyat (BBRI.JK) on the back of its ‘strong micro-finance franchise that puts it in a robust position to keep growing its dividend’, and China Merchants Bank (600036.SS) which had ‘one of the smallest net profit declines of all Chinese banks in the first half of 2020’ and even managed to increase its dividend pay-out ratio.
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