Omar Negyal, JP Morgan Asset Management
The $484m JP Morgan Emerging Markets Dividend Fund, co-managed by London-based Negyal, aims to combine high income and capital growth, but the emphasis is always on buying dividend-paying stocks in emerging markets.
“A regular dividend payout history and strong corporate governance, including respect for minority shareholders, is a prerequisite for the type of stock that we invest in,” he told FSA in an interview.
The fund aims to earn a minimum yield of 4.8%, about 30% higher than the average yield of the emerging market universe. The yield based on its monthly distribution in March is 5.17%.
The average dividend payout ratio of emerging companies overall is 35%, which Negyal thinks will be stable for the next few years.
“A dividend culture has developed throughout emerging markets, even during tough times,” he said.
The fund has a three-year cumulative return of 37.73%, lower than the index (42.99%), but better than the emerging markets sector average (32.5%), according to FE Analytics data. Its annualised volatility of 12.17% is less than the index (14.65%) and the sector average (12.21%) – which perhaps it should be, due to its income focus.
The fund currently holds 73 individual stocks, and the process for selection is “bottom-up” driven. Due diligence assesses a company’s profitability, the consistency of its earnings and whether it deploys its capital appropriately.
The fund doesn’t use a country or sector allocation model, but there is a “clear tilt to some countries that have a strong dividend-paying culture,” said Negyal.
For instance, Brazilian companies are required by law to distribute 25% of their earnings to shareholders and several South African firms make decent payouts and reinvest their remaining earnings productively.
Also, Taiwanese companies, such as the fund’s largest stock holding, Taiwan Semiconductor, have paid regular dividends for many years, and there is domestic pressure on companies in the UAE and Saudi Arabia to distribute parts of their earnings, according to Negyal.
The fund’s most significant recent portfolio change was to raise China exposure by eight percentage points late last year, after “valuations had fallen to attractive levels”. Purchases included financials (especially insurers such as Ping An and China Pacific Insurance), and also consumer sector A-shares. A long-time holding is Midea, the electrical goods manufacturer, which the fund bought in 2015.
“We have broadened our coverage of A-shares due to the diversity of the market and the increasing willingness of many Chinese companies to pay dividends,” said Negyal.
These do not include the big tech growth stocks, such as low dividend yielding Tencent and non-dividend paying Alibaba, so the fund will always diverge from its benchmark MSCI Emerging Markets index.
Negyal also added Mexican holdings last year and reduced exposure to Brazil. Although presidential elections in both countries affected their stock market’s performance – negatively in Mexico, positively in Brazil – comparative valuations of individual stocks accounted for the shift in the portfolio, not politics directly.
“The sell-off in Mexico provided an opportunity to buy good quality consumer companies at cheap valuations with high dividend yields. On the other hand, the rally in Brazil stretched valuations for some of the stocks we held, and so we took profits,” he said.
Typically, the holding period for each stock is four-and-a-half years.
“We sell a stock when its payout disappoints, if the original investment thesis changes – for instance, a shift in business focus – or if its price rises enough that its valuation becomes expensive and its dividend yield too low,” he said.
Negyal insists that surprises are rare, but recalls a Brazilian loyalty card company that last year announced an unexpectedly low payout ratio for 2019, and instead was “diverting its cash inappropriately”.
Avoiding dividend surprises
The screening process of 1,100 stocks covered by 40 analysts goes through several stages to avoid a similar outcome.
First, companies are classified into three categories: premium, quality and trading.
“Although most emerging market stocks fit into the trading category, about 70% of our portfolio comprises premium and quality stocks,”
Quality companies are those with strong corporate governance, a record of treating minority shareholders well, a consistent history of paying cash to shareholders, dividend sustainability and potential for dividend growth. Premium companies have these same characteristics, but are also especially good value stocks, trading at attractive earnings multiples.
Second, stocks are segmented into three dividend yield ranges: 3% to 6%, which make up about 60% of stocks held in the portfolio; 1.5% to 3%, which are higher growth, low dividend paying stocks; and 6% or more, which are utility-type or cyclical stocks.
Next, the analysts estimate the expected five-year returns of the stocks filtered in the earlier stages, which they reckon to be in the high teens. Their projections incorporate earnings growth, likely dividend payouts, valuations (price-to-book and price-earnings ratios) and, importantly, currency forecasts.
“Assessing foreign exchange direction is a critical part of the stock selection process, because it can have such a major impact on returns in our US dollar-based fund. Hedging is usually too expensive, so we consider foreign exchange as a ‘hurdle rate’ to surmount,” said Negyal.
Beyond dividend payout surprises, the greatest risk to the fund’s performance is a protracted US-China trade dispute.
“This would have a negative impact on the Chinese economy, which in turn would likely lead to a slowdown in other emerging markets as their export earnings decline. Already, the uncertainty has made some emerging market companies cautious and consumption has also come under pressure,” he said.
“An economic slowdown would reduce corporate earnings and hence lower dividend payouts.”
The JPM Emerging Markets Dividend Fund vs the MSCI Emerging Markets Index and emerging markets equity sector average