JPMorgan Emerging Markets Growth & Income (JMGI) posted a 54.5% portfolio return for the year to 30 June after the £1.6bn investment trust’s asset class enjoyed its best 12 months in a decade.
In common with other Asia and emerging market funds, JMGI’s unusually strong growth in net asset value (NAV) was driven almost entirely by semi-conductor and hardware suppliers to the global build-out of artificial intelligence (AI).
TSMC, the Taiwanese company with a virtual monopoly in leading-edge logic chips, and SK Hynix, the Korean producer of DRAM memory chips, were particularly important, said JP Morgan fund managers Austin Forey and John Citron.
TSMC is the trust’s top position commanding 17.5% of net assets and has been a significant holding for 20 years.
By contrast, SK Hynix, in third place at 7.9%, was only added to the portfolio 18 months ago when the managers realised it was no longer a second-tier producer overshadowed by Samsung Electronics (ranked second at 9.1%).
Why Hynix had to rally …
Two things stood out to the managers back then about SK Hynix: “first, that a technology shift in DRAM design uniquely favoured Hynix against the two other leading producers, and second, that the scale of investment in AI capabilities was producing a spectacular price cycle for Hynix’s products which was really not reflected in its share price.”
The portfolio’s advance during the 12-month period underpinned an even better 55.9% total return to shareholders as the shares narrowed their discount to NAV from 8.2% to 7.7%, helped by the board’s share buybacks and the 4% dividend policy adopted last year.
Both figures beat the MSCI Emerging Market index which rallied 48.2% with the managers maintaining a large exposure to technology hardware producers, though they reduced some of the holdings later in the year.
Forey and Citron said the contribution from tech hardware was disproportionate. Excluding the sector, the index would have risen only 8% they said. Including other “AI enablers” in adjacent sectors, such as power equipment companies and metal mining companies, made the dominance of the AI theme even more pronounced, they said.
“On the other side, companies in several other industries came to be seen as ‘AI losers’, their business models potentially threatened by the development of AI models, even though in some cases there is little in their results so far to suggest this is the case,” they added.
… but earnings could fall
Unsurprisingly, the managers were positive on prospects for their portfolio of quality growth companies making superior returns from strong balance sheets. In aggregate, they said their stocks were valued at just under 10 times forecast profits for the next year and an expected dividend yield just above 3%. That compared favourably with the index which stood on a higher price to earnings (P/E) ratio and lower yield.
However, they acknowledged there was a greater risk of cyclicality, ie a fall, in portfolio earnings after the tech boom. “SK Hynix is probably the stock with the lowest P/E ratio in the entire portfolio, because the market is already pricing an earnings cycle into its stock price. So we need to be careful that we are not achieving low valuations for the portfolio by simply taking earnings risk instead.”
Indeed, Hynix shares, having rallied spectacularly since the start of last year, the stock has tumbled 36% from a peak at 22 June after a sector-wide sell-off in July exacerbated by the near collapse of the Situational Awareness hedge fund.
The managers said the earnings risk was why they had trimmed IT positions and would continue to do so to decrease their dependence on one area. IT stocks rose to 48.4% of the portfolio at 30 June from 32.7% a year ago but by 31 August had been reduced to 43.6%, though that was still a 2% overweight to the index, according to the trust’s factsheet.
Charges trimmed
Reflecting the increase in the size of the assets, the JMGI board got JP Morgan to trim its tiered annual management fee by 0.05% to 0.7% up to £500m, 0.6% up to £1bn and 0.55% above that.
It all bodes well for the three-year continuation vote at the annual general meeting in November, which the board strongly recommended shareholders support. At the 2023 vote, 99.97% of shares cast were in favour so an upset looks extremely unlikely.
Chair Aidan Lisser said he would retire at the AGM next year. Senior independent director Helena Coles will succeed him.
Our view
David Batchelor, senior analyst at QuotedData, said: “JMGI’s NAV return ahead of the benchmark is a welcome improvement after last year’s disappointment when the trust reported small level of underperformance. The decision to buy SK Hynix before its exceptional rally paid off, although weaker Indian holdings offset some of the gains. Trimming semiconductor exposure looks sensible when today’s low earnings multiples may flatter valuations near a cyclical peak. The fee cut is welcome, while NAV growth feeds directly into higher payments under the existing enhanced dividend policy. However, with the discount back at 9.1% despite substantial buybacks, stronger performance has yet to translate into a lasting improvement in the rating.”
