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JPM's Negyal stays cool as emerging markets rally
Emerging markets have enjoyed a recovery in 2016 after five years in the doldrums. But Omar Negyal isn't getting carried away.
Stock markets in the developing world have performed well in 2016, after five years in the doldrums, with investors in Brazil enjoying a particularly explosive rally.
But Negyal believes an improvement in earnings from companies from the region to power the next leg of the rally.
JEMI is the only broad emerging markets investment trust with an income focus, although there are More focused Asian and Latin American income trusts.
Can't watch now? Read my script
Daniel Grote: Hello! Joining me today is Omar Negyal, who is manager of the JPMorgan Global Emerging Markets Income investment trust. Thanks for joining us, Omar.
Omar Negyal: Good to be here.
DG: Now the main question that any investor in emerging markets will have for you, I’m sure, is the rally we have seen over the last couple of months – is that the start of a longer term turnaround in the sector that’s had a pretty glum three years.
ON: you’re right to highlight that the cycle has been pretty negative recently in the last few years, although we’ve seen this pick-up in recent weeks. I think this really comes down to where we are in terms of earnings. I think we’ve been in a weak part of the cycle from an earnings viewpoint and I certainly see that when I talk to the companies that we invest in. We still need to see that turn round to be really confident in the near term about the recovery continuing.
DG: Because if you look at the fundamentals for emerging markets, some of the issues which were talked about as the big problems – China slowing down, the US first tapering quantitative easing and then raising interest rates – those issues haven’t gone away and in a sense they have become more pronounced this year. So what’s going on? Why are stock markets moving higher?
ON: I think what’s happening is stock markets are trying to discount where we are in terms of that cycle. And it does seem to me that we’ve come through a long way in terms of the adjustment process that we needed to go through. Let’s take currencies as an example, because that’s certainly been an area of weakness. Emerging market currencies have generally been weak versus sterling. I would say that we’re a pretty long way through that adjustment process. Emerging market currencies look on average cheap and certainly cheap compared to where they’ve been trading in recent years, and that provides an opportunity.
DG: And just looking at gearing, or the amount of money that you borrow to then invest and amplify returns if stock markets go up. You are geared, you have around 7% gearing in the trust, whereas none of the other investment trusts focused on emerging markets do. Now that suggests that you’re pretty bullish about prospects.
ON: I think it’s important to highlight that the gearing in the trust, which we’ve had for some time now, essentially I see that as a way of enhancing the income profile of the trust. So we’re still in an era of low interest rates, possibly rising but at a slow pace, and when we compare those low interest rates to the attractive dividend yields that we can obtain from emerging market equities, it seems to us pretty sensible to have a moderate level of gearing in the portfolio to take advantage of that and to enhance the income profile of the trust.
DG: And you are the only emerging market investment trust that does have this income focus, and I think you’re yielding around 5.4% at the moment, which is not outlandish, but it is high, and investors will question, ‘Well, is that sustainable?’. Is it?
ON: I think it’s right to highlight that the cycle in emerging markets is weak, so I think we need to be a little bit cautious about near term prospects for earnings from emerging markets companies, and therefore the dividend prospects in the near term. Emerging markets are still driven very much by payout ratios. There are some companies in emerging markets that have true progressive dividend policies, and where we can find those, I’m very happy to invest in them. But that’s still the minority. So most of our companies, generating good returns, but where the dividends are tied to a payout. So ultimately they are tied to the earnings cycle.
DG: And just lastly, tell me a bit about Brazil. The stock market has rallied very hard since the turn of the year, and there have been some pretty intriguing political developments. How do you see that playing out? Is the stock market getting ahead of itself?
ON: So Brazil was extremely weak last year, and as you say it has been recovering this year, which has been helpful for us. Partly I think the currency and the market just got too cheap. This is one of those overshoot examples that I was talking about. The real became pretty cheap last year and we took advantage of that, we were adding to Brazil through the second half of last year, to go to a mild overweight ion that market. Now Brazil is going through a deep recession, there is no doubt, arguably one of the worst recessions it has ever experienced, so very difficult economic conditions. We are trying to own companies that can survive and thrive through that and still generate decent returns.
As you’ve mentioned, a key change could be politics. If we see a political development that encourages reform and that encourages some kind of better structural growth profile for the market and for the economy, that’s got to be a pretty positive outcome.
DG: And stock markets are getting excited about the prospect because they think the current president is going to go…
ON: It’s an extremely volatile environment. I don’t want to speculate too much exactly on how the political development is going to pan out. It seems as if there is a higher chance there could be political change which is likely to be positive. But I think that ties into the fact the market was already looking relatively cheap from both a currency and valuation perspective, and that’s an important thing to bear in mind, particularly from a yield perspective.
DG: Omar, thank you for your time.
ON: Thank you.
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