With the two largest trusts in the IT Global Emerging Markets Equities sector currently trading on hefty discounts wider than the sector average, investment professionals have questioned whether investors should treat this as a potential buying opportunity.
Wide discounts are likely to pique investor interest given that the sector has grown its dividend by an average of 8.6 per cent per annum over five years and has acheived a return of 31.76 per cent over the last year alone.
Performance of sector over 1yr
Source: FE Analytics
Not only are investors able to take advantage of any potential discounts when it comes to buying into closed-ended vehicles, there is an argument that they are better-suited to holding more illiquid assets such as emerging market equities.
In an article published earlier this month, star manager Terry Smith explained why he opted to launch Fundsmith Emerging Equities as an investment trust rather than a fund, warning that emerging market OEICs will “only end in disaster”.
“In my view, it is irresponsible to buy things with limited liquidity in an open-ended vehicle,” he said. “Sooner or later everyone will head for the exit at the same time and you will be unable to satisfy them.”
As such, we decided to look at the two largest investment trusts in the market area: Templeton Emerging Markets, which is £2.2bn in size, and JP Morgan Emerging Markets, which has an AuM of £1bn.
The former, which is managed by Mark Mobius and Carlos Hardenberg, is trading on the wider discount of 13.4 per cent, according to data from the Association of Investment Companies (AIC), compared with the sector average discount of 10.4 per cent.
It aims for long-term capital appreciation which it looks to achieve through a concentrated portfolio of high-conviction stocks. Its largest holding, Brilliance China Automotive, accounts for 7.1 per cent of the overall portfolio while its second largest holding, Samsung Electronics, accounts for a further 6.9 per cent.
It prides itself on being one of the first dedicated emerging markets trusts in the UK, having launched in June 1989.
While Mobius has taken a step back in terms of managing the trust and Hardenberg is now lead manager, it adopts a similar investment process which is value-orientated and benchmark-agnostic.
As such, it may not be best-suited to the more cautious investor as, over five years, it has a maximum drawdown (which measures the most money lost if bought and sold at the worst possible times) of 37.68 per cent compared to its average peer’s drawdown of 20.12 per cent.
Over the same timeframe, it has struggled to outperform its average peer and MSCI Emerging Markets benchmark; this can be attributed to sharp losses in 2013 and 2015, when it ended both years down 8.86 and 23.93 per cent respectively.
That said, it has been the best-performing trust in the sector over the last year, having outperformed its average peer and benchmark by 21.23 and 12.95 percentage points with a return of 52.57 per cent.
It has a five-year dividend growth of 5.7 per cent per annum, a dividend cover of 4.34 years and revenue reserves of £109.9m. The trust, which is 2 per cent geared, yields 1.2 per cent and has an ongoing charge of 1.21 per cent.
JP Morgan Emerging Markets also yields 1.2 per cent although it has a smaller dividend cover of 1.2 years and revenue reserves of £16.99m.
However, the trust has achieved stronger total returns than Templeton Emerging Markets over three and five years, although it has underperformed it by 18.38 percentage points over the last decade with a total return of 106.79 per cent.
Performance of trust vs sector and benchmark over 5yrs
Source: FE Analytics
It may, however, present itself as a better option for lower-risk investors given that it has a lower five-year maximum drawdown than its sector average and benchmark at 18.61 per cent.
Headed up by Austin Forey since 1994, the trust adopts a disciplined approach to portfolio construction and markets itself as a ‘best ideas’ investment vehicle consisting of between 50 and 75 stocks at any one time.
Its largest individual weightings are Housing Development Finance and Taiwan Semiconductor, which each account for 5.5 per cent of the overall portfolio. The trust aims to outperform its MSCI Emerging Markets benchmark over the long term through a combination of both macro market selection and individual stock selection. It can use gearing to maximise profits although it currently isn’t levered at all.
It has a five-year dividend growth of 14.9 per cent per annum and has an ongoing charge of 1.16 per cent.
Out of these two heavily-discounted trusts, which would be the better option for investors looking to gain exposure to emerging markets through a closed-ended vehicle?
Adrian Lowcock, investment director at Architas, says JP Morgan Emerging Markets adopts a notably long-term approach.
“It focuses on businesses which have good earnings, strong balance sheets and excess returns on capital,” he explained. “Forey tends to have a bias towards domestic consumption leading to a bias towards financials and consumer staples over commodities and energy. Forey will also buy small-cap which has been a key driver of returns.”
When it comes to Templeton Emerging Markets, Lowcock notes that its change in management has indeed led to some changes within the trust which investors should be aware of.
“The fund continues to have a large-cap bias but Hardenberg has introduced a growth element and increased the number of holdings to 80,” he said.
“It is still early days in the new manager’s tenure but he has a lot of experience with emerging markets and in particular frontier markets.”
Victoria Chernykh, senior research analyst at Panmure, says the Templeton trust’s significant underperformance over recent years cannot be ignored. Having met Hardenberg when he first joined the helm of the trust in 2015, however, she particularly liked his investment process and philosophy.
“I think that, since then, my opinion has become more positive on the trust. It has a new manager who I think is competent. Mobius of course is too, but he was perhaps simply too busy to manage the trust alone,” she reasoned.
“In terms of the JP Morgan trust, it is also strong. It aims to identify stocks which are more profitable than the index but trade on reasonable valuations. The trust has been a solid second-quartile performer for a long period of time. It has a good management team.
“In terms of which one I would prefer to go for now, it is a difficult question. However, given the Templeton trust’s past underperformance, perhaps it has more upside.”
When comparing them like-for-like, however, she says they are both decent investment trusts. While she is unsure why they are trading on such wide discounts, she says it is likely to be the result of overarching negative sentiment towards the sector.
Not everybody believes the decision between the two is such a close call, though. Ben Yearsley, director of Shore Financial Planning, agrees the discounts are predominantly sentiment-driven and believes investors should take advantage of the current discounts on offer. However, he would opt for the JP Morgan Emerging Markets trust over Franklin Templeton Emerging Markets.
“I haven’t been convinced by Templeton for a while,” he said. “I have always thought it has been a little overrated so, out of those two, I would be looking at JP Morgan; Austin is a really good manager. I would take advantage of the discount.
“I just don’t think Franklin Templeton has delivered the returns. They have been held up as a ‘wow’ manager for years but I don’t think they’ve delivered. I would choose JP Morgan definitely.”
Dennis Hall, chief executive of Yellowtail Financial Planning, has purchased both trusts in the past but currently holds the JP Morgan investment vehicle.
“I think the trust has the better spread and the methodology just felt better,” he said. “Rightly or wrongly, there is something about Templeton that feels that it all hinges on one person.
“Mobius has been the face of the trust for as long as anyone can remember and it seems to hinge on this rather than the process - Mobius has been a brilliant spokesperson for the sector. I could well be wrong, but that is the impression I get.
“My feeling is that there’s more process with the JP Morgan trust. There is the entire fund house process behind it. I know Templeton has a process but it feels slightly removed and it does have that ‘star manager approach’, which can be seen across a number of its funds.
“I think if you’re going to buy into emerging markets and hold, I think the current discounts might be a good reason to do so. If you think you should have emerging markets in your portfolio, I am favouring the JP Morgan fund out of the two.”