Emerging markets are going through a tough period in the economic cycle, but investors shouldn’t forget that there is a strong dividend-paying culture in many regions within the sector, according to Omar Negyal.
The manager, who co-runs three emerging market investment vehicles for JP Morgan including their Emerging Markets Income Investment Trust, says that the sector has had a steady pay-out ratio of between 30 and 35 per cent for many years, yet this is often an aspect that is forgotten about by investors.
Many have been bearish on emerging markets for the last five years following 2013’s ‘taper tantrum’, China’s growth slowdown and the collapse in commodity prices.
Performance of indices over 5yrs
Source: FE Analytics
Negyal agrees that emerging markets have been painful for a lot of investors, with his own trust falling into the bottom quartile over the last year, but he says that it is important to adopt a long-term stance and look through any potential short-term noise that is bruising markets.
“It’s clear that emerging markets are in a difficult part of the economic cycle – the profit streams of companies in emerging markets have been under pressure,” he admitted.
“I think China is an important part of that – it’s the engine of growth for emerging markets so that’s had a knock on impact to the rest of emerging markets as well.”
“I do think it’s a cycle and ultimately emerging market companies will come through the other side as they have done through other cycles, but I think it’s realistic to say we’re in a tough part of that today.”
While investors have been right to avoid emerging markets for most of the last few years, the huge index falls and depressed sentiment has left developing world equity income funds on attractive yields.
Current sector and index yields
Source: FE Analytics
According to FE Analytics, the average equity income fund in the IA Global Emerging Markets sector now yields 4.3 per cent while the average IA Asia Pacific ex Japan fund with a dividend tilt yields 4.8 per cent.
That compares to the IA UK Equity Income sector’s average yield of 4.19 per cent and a 3.8 per cent yield from the FTSE All Share.
Negyal continued: “There’s a dividend culture that’s come through in emerging markets and on average companies are going to pay you dividends.”
“I think investing via dividends in emerging markets is much more than just getting an income - I think dividend investment is simply a good way to invest in the asset class. There are two reasons - one is that a dividend yield gives you a value signal, and two I always think of this strategy as value combined with quality.”
“Yes you’re getting the value from the yield, but the dividend tells you something about the governance of the companies. Emerging markets are risky for different reasons, and by focusing on companies that pay dividends and are hopefully more minority shareholder-friendly, we’re more likely to get a better outcome in the long term.”
When investors look at emerging markets from this perspective rather than in a pure value or growth context, though, they may be surprised at which regions within the sector are offering the most lucrative opportunities.
For instance, Negyal’s two biggest regional overweights relative to his trust’s MSCI Emerging Markets TR’s benchmark are Taiwan and South Africa. While Taiwan has grown increasingly popular among emerging market investors because of its strong currency and its strong current account surplus, South Africa has been immensely unpopular due to the barrage of macroeconomic headwinds it’s faced over the years.
“Regarding South Africa there are clearly concerns surrounding the currency and the macro environment is bad. I can find very good companies there at attractive valuations, but there are clearly broader risks for the region,” the manager said.
“That was evident in [the trust’s] performance last year – it was dragged down by our South African exposure, partly because the rand had depreciated. Currencies have become cheap and I think there’s an opportunity there, but essentially what happened was cheap became cheaper.”
“To me that’s opened up opportunities so I’ve actually been adding to South Africa over the last year. I’ve been able to add to high quality companies where the yields have become more attractive.”
The manager and his team adopt a bottom-up stock selection process and he describes himself as “agnostic” as to where he find the stocks that he likes. However, he says there are still particular areas of the market where he finds more opportunities than others.
For instance, Negyal has been gradually increasing his exposure to Brazil over the last 12 months despite the fact that the area has been under immense economic pressure due to its continued recession, its weak industrial growth and reduced levels of consumer spending in the region.
“The reason that Brazil is inherently an interesting place for a dividend investor is that there’s a mandatory dividend. In some ways it’s surprisingly different from other markets whereby companies have to pay at least 25 per cent of their earnings to shareholders,” Negyal explained.
“So that’s a very nice starting point. From my point of view I need to weigh up that positive dividend angle with the risks that do exist in that market. There are some clear macro growth problems in Brazil so it’s a case finding the balance between the two, but I’m naturally attracted to that market because of that.”
Another contrarian area of emerging markets that the manager says is appealing from an income perspective is the Middle East, which is of course fraught with political tension.
However, he says that markets such Saudi Arabia and the United Arab Emirates are particularly rich hunting grounds for attractive dividend yield investments.
“This is partially due to the development of the dividend culture in these regions, and if we think about why that is, the history of these markets is that they were essentially set up to help cash distribution to local citizen investors, to help the oil wealth transfer,” he said.
“That’s where the dividend culture began and obviously things have moved on from that. Now we have more private companies in the market it has become a more fully-functioning stock market, but that legacy of emphasising dividends is still there, which is why it’s inherently an interesting place for me to go and look for dividend investments.”
Since Negyal’s joined the helm of the JP Morgan Emerging Markets Income Investment Trust alongside Richard Titherington in 2013, it has provided a total loss of 23.83 per cent compared to its sector average’s loss of 15.7 per cent and its benchmark’s loss of 12.6 per cent.
Performance of trust vs sector and benchmark under Negyal
Source: FE Analytics
However, it must be noted that the investment team has a five-year investment outlook and will choose attractively-valued stocks that it deems to be an appealing investment over the long term.
The £254m trust is currently trading on a 7 per cent discount, is 7 per cent geared and yields 5.7 per cent. It has an ongoing charge of 1.24 per cent.
