Gentle outperformance from JPMorgan Emerging Markets

JPMorgan Emerging Markets (JMG) has announced its annual results for the year ended 30 June 2020, during which it has provided a gentle outperformance of its benchmark (the MSCI Emerging Markets index with net dividends reinvested, in sterling terms). During the year, JMG provided NAV and share price total returns of 2.7% and 0.7% respectively, which are ahead of the benchmark’s fall of 0.5%. The manager, Austin Forey, says that the pandemic has accelerated trends that were already in place in emerging markets and it is encouraging that a number of positions had already been taken in the portfolio in anticipation of these trends.

JMG faces a continuation vote at its upcoming AGM (shareholders are offered a continuation vote every three years). The Board has also decided to make permanent the temporary investment restriction that it introduced in April that prevents any single region being 10% or more above the equivalent benchmark weighting (this is in addition to JMG’s existing limit on a single region not being more than 50% of its assets). The board is also proposing 10 for 1 share split. This is to be put to shareholders in a vote at the upcoming AGM.

Comments from Austin Forey on the investment returns

“At first glance, returns for shareholders during the latest fiscal year to 30th June 2020 were nothing to write home about: the total return on net assets was 2.7% over the year, while the total return on the share price was only 0.7%, because the discount to NAV widened during the year. But I hope shareholders will see these numbers in a broader context. Not only was this a year in which the asset class as a whole delivered a marginally negative return (as measured by our benchmark index, which declined by 0.5%), it was and will no doubt be remembered as the year of the pandemic. Given everything that has transpired in the last few months, it is good to be able to report even a modest gain in value for the Company’s shareholders. Even though this was anything but an average year, the underlying value added to the Company by active management, measuring the portfolio return before costs against the index return, was 4.0%; this is in fact almost exactly the same as the average annual “manager contribution” over the last 12 years.

Austin Forey on his guiding principles

In past reports I have tried to explain not just how we approach investment, but the rationale behind our process. This year, we have expanded this to a set of guiding principles which I hope will offer shareholders not just the comfort of seeing that the portfolio “does what it says on the tin”, but also that it will continue to do so. These guiding principles are intended as enduring statements of basic investment beliefs.

First and foremost is we aim to take a long term approach to investing. This brings two simple but powerful effects for the portfolio. First, if we can find businesses whose value compounds in a sustained way, they will eventually have a big impact on the overall value of the portfolio; nothing is as powerful as compounding over long periods. Second, such an approach minimizes transaction costs and thus helps overall returns to shareholders; the long term effects of this should not be underestimated.

In the past year, we changed about 10% of the portfolio, as can be seen in the statistics in the annual report: these show that we made purchases of £134m on a portfolio or £1.3bn. Another way of thinking about this is that our average holding period for investments is roughly 10 years, which I hope supports our claim to be taking a long term approach.

Our second guiding principle is to use fundamental research to manage the portfolio actively, something we have been doing now for almost three decades already. Yet in that time, our research capability has developed to something entirely different from where we began. Twenty years ago, I was both a portfolio manager and a researcher of ideas, but as the asset class expanded and became more complex, it was clear that we would need more resources, and so almost fifteen years ago we started building a team of analysts dedicated solely to researching companies in emerging markets. Today that team numbers over 40 analysts: it’s a very diverse group of people, reflecting the diversity of investment options we see before us. Most importantly, this diverse group works with a common research framework, which allows us to select the most suitable ideas for the portfolio, no matter where they are found. The core of our research process has always remained the same, and focuses on understanding the basic economics, duration and governance of any company we look at. But our approach has also evolved as appropriate: in the last decade we have introduced new elements into our research to better capture the environmental and social risks faced by companies.

As for managing the portfolio actively, this should not of course be understood to mean that we are constantly trading shares. Rather, shareholders should understand that we pay little attention to the index when constructing the portfolio and have always been prepared to take positions which differ significantly from the benchmark, both at the individual stock level, and when seen in aggregate. We are really only interested in particular kinds of companies and we find them most often in certain industries, as I explain below when talking about sustainability. The portfolio reflects this.

Our next principle is to focus on stock selection above all. More than anything else, we are trying to find the best individual companies to invest in. Of course, we think about the context in which they operate, the currencies to which they are exposed and other macro-economic effects and risks. But we have never set out to be “overweight” or “underweight” in a particular country or industry, we have always just pursued the best investments, wherever we could find them. This has led us to opportunities that a more “top down” approach might well have missed. In the last few years we have invested in three companies, two based in Argentina and one whose principal operations base is in Belorussia, and between them these investments have added significant value to the portfolio. It is very unlikely, had we been thinking at a country level, that we would ever have found these opportunities; more likely, we would have dismissed both countries out of hand.

We focus on stock selection for three reasons. First, and most importantly, it’s where we have added value in the past and where we think we can do so in the future; it’s what our research process is designed for and it’s what our analysts do. Second, it gives us far more choices than a process led by selecting countries as the primary decisions factor; as an investor, the more things you have to choose from, the better. And third, a focus on individual company investments leads us naturally to think a lot about what makes any company stand out, and the stocks we tend to like the most, and keep the longest, are those where we remain most convinced of the company’s competitive strengths and of its ability to create value with those strengths. Why does this matter? Because if we can find opportunities that are very company-specific, they are intrinsically diversified, because they rest on factors which other companies cannot replicate. The more each investment in the portfolio is driven by idiosyncratic factors, the more truly diversified the portfolio is in the long term.

Our last two principles are less to do with decision making and address instead our broader conduct as investors of capital on behalf of the Company’s shareholders. We set out to act as a responsible and engaged shareholder of the companies that we have invested in on shareholders’ behalf. In a way this seems so obvious that it hardly needs saying: we conduct thousands of meetings with companies every year and, over time, dozens of meetings with the same individual companies which may stay in the portfolio for years and years. These are not one-way discussions – we offer companies our opinions and our views, especially on issues like capital allocation and governance which lie beyond the purely operational remit of management. Always, we present arguments with the intention of helping a company extend its competitive duration and enhance its long term value. We always vote the shares that the portfolio holds and information on our voting over the last year is shown in the annual report.

We see a responsibility not just to challenge and question management teams, but to engage where we see scope for improvement, whether it is in something as simple as the composition of the board or the transparency of reporting, or in a more complex area. Sometimes we simply offer a broader perspective, because we look across many countries and many industries. But the essential thing is to view ownership of a company’s shares as an activity in its own right; active management does not mean trading the stocks in the portfolio incessantly – it is about sustained engagement with leading companies over many years, in pursuit of better outcomes for all. We have always done this, but we also look for ways to improve what we do, and one enhancement to our research process that we have introduced in the last year has been the development of a “materiality framework”, identifying the most important ESG factors in over 50 industry categories, as chosen by our research experts. This not only allows a far sharper focus on how companies are performing in the areas that are most significant for their particular industry, it also helps us drive targeted engagement on the most important issues for any single company. I look forward to reporting on this in more detail in the future as we accumulate more experience in applying this framework.

Lastly, we want to use the benefits of the closed-end fund structure for shareholders. What does this mean in practice? Primarily, we have been able to make investments in some smaller companies, where the liquidity of the shares would have been inappropriate in a fund offering daily subscriptions and redemptions. Shareholders should know, however, that we have done this selectively. These investments have never made up a large part of the portfolio, but they have added value; and of course if they are really successful investments, then over time those companies become larger and their shares more liquid. One of our largest investments today, HDFC, was a $750m company when we first invested in it in 1998 and not at all easy to buy. Today, that company’s shares typically trade $100m in a day and its market value is over USD 40bn; this is an admittedly extreme example of why we have been prepared to take liquidity risk in specific outstanding investments, something that the closed fund structure of an investment trust makes possible.

Austin’s comments on the year and the portfolio

The past year – performance attribution for the year ended 30 June 2020


% %
Contributions to total returns  
Benchmark return -0.5
Asset allocation -0.2  
Stock selection 4.2  
Currency effect -0.2  
Net cash 0.2  
Investment Manager contribution 4.0
Portfolio return 3.5
Management fee and expenses -1.0  
Share buybacks 0.2  
Return on net assetsA 2.7
Return to shareholdersA 0.7

Source: JPMAM/Morningstar.

All figures are on a total return basis.

Performance attribution analyses how the Company achieved its recorded performance relative to its benchmark.

A Alternative Performance Measure (‘APM’).

A glossary of terms and APMs is provided in the annual report.

It has, in that most clichéd of footballing clichés, been a year of two halves: before the pandemic; and then the pandemic. Everything altered, and yet in some ways, established trends just accelerated. Until late February, markets paid little attention to the virus that was already spreading slowly outside China. But that all changed suddenly and emerging stock markets, like all others, suffered sharp declines and the most severe market panic since the financial crisis of 2008-09. Since the end of March, they have also staged a gradual recovery, to the point that, as I write, the asset class has more or less recovered to the level at which it started the year, in sterling terms. This may seem a surprising outcome, given the damage inflicted on the global economy by the pandemic and the ensuing lockdowns and restrictions on economic activity. But the general trend masks some very divergent specific outcomes. Existing trends in e-commerce, and other online services, have seen accelerated growth and some companies in these industries have seen their share prices reach new highs throughout the last few months. In more traditional industries, there have been plenty of stocks that have some way to go simply to recover recent losses.

Manager’s comments on corporate trends and the portfolio

Recent outcomes for emerging equity markets have been heavily influenced by the way countries have coped with the pandemic, and how quickly they have been able to return towards normality; this explains in part why China has been one of the best performing markets in the last six months, not just among emerging markets, but in a global context. But, although it may seem hard to believe right now, the pandemic will pass and economic fundamentals and corporate skill will re-emerge as the most important determinants of long term investment outcomes.

And that leads to an important and, I think, very encouraging trend in emerging markets: they are becoming more like developed markets. What do I mean by this? Not that they have achieved economic convergence; rather, that value creation in the corporate sector is being strongly driven by very similar factors in both areas. Digitalisation, the development of internet-based business models, the creation of intangible value rather than reliance on physical assets and large amounts of investment in fixed assets – these are far more widely seen in emerging markets today than in the past, as, as can be seen simply by looking at the trust’s ten largest investments.

In fact, the majority of the portfolio is invested in sectors which broadly fit this characterisation – software services, internet services, gaming, consumer brands, even stock exchanges. This is important because companies that do not have to invest large amounts of capital tend to generate higher returns on capital, require less leverage, and ultimately generate more cash for shareholders, all highly desirable qualities in an equity investment. Moreover, the value added by intellectual property is highly specific to the company that created it, and less easily replicated. By contrast, businesses which have low value-added and are capital-dependent will always, in my view, see their returns trend towards the price of capital, which today is lower than ever. And that is why the portfolio today concentrates heavily on the former and avoids the latter. It has no exposure to capital intensive industries like basic commodities, real estate, utilities or heavy industry. As a result, the Company’s portfolio is also made up of businesses whose returns on capital are significantly above the average emerging market company, something that is unlikely to change.

Looking forwards, the manager sees a sustainable future

Much more attention is now being paid to the notion of sustainability in the practice of asset management. In fact, the word “sustainability” has acquired a specific and, one might argue, narrow meaning in this context. Given both our long term focus and our long holding periods for investments, we have always been interested in sustainability, defined in the broadest way, which is closely tied both to competitive advantage and strong economics, as well as to responsible corporate behaviour, and our investment approach has always incorporated this. There is no doubt, however, that the focus on corporate responsibility in general, and climate change in particular, is changing the criteria for successful long term value creation in the corporate world, making effective consideration of sustainability factors all the more essential. For the best companies, great opportunities abound; for the worst, irrelevance and extinction lie ahead.

The Company’s portfolio naturally tilts towards industries with a carbon footprint that is better than average, and this is reflected in some of the data we show on the portfolio in the annual report. But in a more detailed way, we now regularly challenge and interrogate companies on issues that are really specific to what they do – and that could be the way that an alcohol producer markets its products to consumers, or the way a semiconductor company is increasing its use of renewable energy sources. As a really granular example, we recently engaged with a pharmacy company to discuss its use of inappropriate third-party advertising from a product manufacturer, to understand how a mistake had been made, what had been done about it and how repetitions would be avoided in the future. This is a typical example of the detailed discussions that we have with companies across a wide range of industries and geographies.

We are not looking for average companies and average solutions will not be enough to produce sustainably superior outcomes. The best companies understand this and understand also that the corporate sector has to play a major role in an enormous economic transition that is needed to secure a sustainable future for all. Companies are often portrayed as the villains in the drama and some of them deserve this characterisation. But without the innovation, the investments and the ambition of the corporate sector, in emerging markets and elsewhere, a sustainable future will be hard to achieve. I remain optimistic both about the contribution that companies can make, and about the investment opportunities this will bring; and therefore I remain optimistic about the prospects of the Company.

4 thoughts on “Gentle outperformance from JPMorgan Emerging Markets”

  1. On 7 Nov 2020 the newspaper reported in Top Fallers section JPM EM. down 89.87%. Does this represent a 10:1 stock split. Very little information about the situation.

    1. Hi Norman, yes the shares were split so that each share is now 10 shares. If the shares fell by less than 90%, in effect they went up!

  2. Hi. Do you know when the share split will be reflected in portfolios held by individuals in a SIP? At this moment I can only see that ca 90% of my value has been wiped off due to the share split (ie the number of shares have not been allocated)

    1. Hi Marc, I’m afraid we don’t know the answer to that one – it should have happened already. Best to contact your trading platform.

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