Richard Titherington, Manager of JP Morgan Global Emerging Markets Income.
Emerging market equities have fallen from favour quite dramatically among investors this year, although this is more to do with the better returns that have been achieved in developed stock markets than with any kind of incipient emerging markets crisis.
Most of the senior policymakers in emerging markets today lived through the crisis of the 1990s and they will not repeat the mistakes that were made then. So while emerging markets might underperform for a while, a full-blown crisis is unlikely. Even if there is some kind of minor crisis, as long-term investors we see a buying opportunity when markets plunge.
There is still huge room for development in emerging markets. In India, for instance, there are only 25 cars per 1,000 people versus 815 per 1,000 in the US. When people get money they buy cars, and we are confident that the pattern of increasing car ownership in emerging markets will increase. Of course there is a problem with that – already traffic and smog are bringing Chinese cities to a standstill, although the rate of car ownership is low. But if you look at London, 50 years ago smog regularly brought London to a standstill, yet today we have far more cars on the road and smog is a thing of the past. China will change and automobile penetration will increase.
As income investors, dividends are a key focus for us. Emerging markets dividend growth is better than that of developed markets, and if you are a long-term investor, the difference between 5% compound and 10% compound over 10 years is remarkable. In addition, dividends are a good measure of corporate governance: you can’t exaggerate a dividend.
We estimate that in the emerging markets universe there are over 400 companies worth over $1bn that have the potential to yield more than 4% a year going forward, compared with 260 companies in the UK. If you drop the forecast yield to 2% there are 700 companies in the UK that could achieve that, but more than 1,000 in the emerging markets universe. Yet income strategies account for a tiny proportion of the total invested in emerging market funds.
The growing number of emerging market companies paying attractive and sustainable dividends is what makes a fund like JPMorgan Global Emerging Markets Income Trust possible. A decade ago you could not have launched an emerging markets income fund as there simply were not enough companies paying dividends to achieve the necessary diversification. Now, while there are some sector biases, the universe has grown to such an extent that you can offer a fully diversified portfolio.
There are three main types of stock we look at for the portfolio. The core is held in stocks that offer a balance of attractive yield and good dividend growth prospects. Then on the one side there are stocks that currently have a high dividend yield but limited prospects of dividend growth, and on the other side, stocks that have good dividend growth prospects but a low current yield. We blend these stocks together to create the optimum balance of current dividend yield and future dividend growth, taking care to avoid high-yielding stocks that may become value traps.
A long-term time horizon with low turnover is key to realising the inherent value in many of these companies, as well as allowing reinvested dividends to compound over time. What a long-term view also gives us is the ability to see opportunities in what others perceive as threats. Right now, emerging markets price/book values (a long-term method of valuing companies) are close to long-term lows. They might be lower tomorrow, but we believe that for investors who share a long view, the potential rewards are there.