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JPMorgan Brazil underperforms during a challenging year

JPMorgan Brazil has announced its final results for the year ended 30 April 2016. During the period, the trust provided and NAV total return of minus 14.4%, underperforming the benchmark, the MSCI Brazil 10/40 Index which returned minus 10.9%. Over the year the Company’s share price discount widened from 6.4% to 10.6% and, reflecting this, the trust’s share price total return was minus 18.2%. The trust says that the Brazilian equity market continued to perform poorly during the year and that a high level of political uncertainty and ongoing corruption revelations undermined consumer and business confidence, leading to a continued contraction in domestic demand.

However, the trust says that there has been some encouragement in the period from a low point of 21st January, when the Brazilian market rose 65% in sterling terms, assisted by a rise in the value of the Brazilian Real which accounted for some 23.6 percentage points of this recovery. This improvement followed the moves towards commencement of impeachment proceedings against President Dilma Rousseff and the subsequent appointment of Michel Temer as interim president and some hopes that his ministry may make progress towards the reforms that are required to facilitate economic recovery. The trust says that during this period its NAV per share rose by 44.9%.

The trust says that the underperformance of its portfolio against the market arose mainly because of the strategy, agreed by the Board with the managers, to avoid the largest companies which they say are volatile and unduly subject to political influence. The manager say that the rally in the final quarter was led by larger, politically exposed companies which they believe to be of low quality, and that this was given further impetus by the closing of short positions held in such companies by local investors.

The managers say that stock selection contributed to and asset allocation detracted from relative the trust’s relative performance. Specifically, an overweight position in the industrials sector detracted from performance, whilst individual stock selection in this sector also detracted from value, with one of the largest detractors being an overweight position in Valid. The managers say that the company, which manufactures chips used in mobile phones and credit cards, had been at the forefront of the creation of chips used in credit cards in the US, where it benefited from the weakening real during 2015. However, it came under pressure as sales proved weaker than expected. The managers say that they continue to like the stock and are confident in its long-term outlook.

Stock selection in materials was detrimental, where an overweight position in Suzano detracted from returns, although not holding Fibria added value. The managers say that both pulp and paper companies fell behind the rally in the Brazilian market, due to weakness in pulp pricing in China and Europe. They say that the results of both exporters were also negatively impacted by the appreciation in the Brazilian real this year. Stock selection and an underweight in utilities also detracted, where not holding steel company CSN detracted from relative performance. The managers say that CSN, which is not held due to their concerns around its high levels of leverage, benefited from short covering during the market’s rally this year.

Positive contributions came from both the sector allocation to consumer staples and individual stock selection within this sector. An overweight position in drugstore chain Raia Drogasil was the biggest contributor at the stock level. The managers say that drugstores continued to report positive same-store sales, beating inflation, in the period. They say that Raia Drogasil also benefited from strong execution by management, resulting in an increase in margins, an expansion in floor space and double-digit earnings growth. The managers are maintaining the trust’s position in the stock, as they believe this trend is likely to continue. Elsewhere in the consumer staples sector, not holding JBS, one of the largest meat producers globally, was also among the biggest stock-level contributors whilst an underweight position in food company BRF, also in the consumer staples sector, contributed positively, as the stock suffered from weakness in the domestic market.

In terms of outlook, the managers say that they remain cautious given the recent strength in the market and believe that the next few months will be crucial to understanding how much interim president Temer can achieve, and whether he is capable of obtaining congressional approval for the reforms that Brazil needs. The managers say that if inflation begins to come down, as they expect, rates will then come down, and this will provide a positive environment for many companies. The managers believe that much of the recession of the past two years is down to confidence, and that if Temer takes the right action, confidence could return to the economy. The managers say that they that Brazil is past the worst of the recession, and they expect earnings to gradually recover from their very depressed levels. However, they believe Brazil’s economic path is likely to be a difficult one, even under the most optimistic scenario, and therefore continue to prefer quality and domestically-oriented stocks with good long-term growth prospects irrespective of the impact of short-term economic conditions.

JPMorgan Brazil underperforms during a challenging year : JPB

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