Investors should maximise EM income opportunity set

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Richard Titherington, Pierre-Yves Bareau and Sebastian Luparia, co-managers of JP Morgan Funds – Total Emerging Markets Income Fund, analyse three of the most commonly discussed emerging market countries to highlight how investors can improve returns and income by combining equity and debt opportunities.

Brazil

Luparia comments: “For equity income-orientated investors, Brazil is as an interesting opportunity as companies within this country have a legal obligation to pay dividends equivalent to at least 25% of their shareholders capital.”

“For example, domestic Brazilian stocks that benefit from the rising urban middle class offer compelling dividends and solid growth.  We also like industrial names with global franchises, as they benefit from the currency depreciation that we expect will continue, as well as changes in local industrial policy and private and public investment.”

As a dedicated cross-asset portfolio manager, Luparia looks across both equities and debt in Brazil and globally to find a balance of superior risk-adjusted returns and stable income.

Russia

Titherington comments: “Investors should remain highly cautious given the uncertain outlook for political risk. Russia is also vulnerable given their heavy reliance on natural resources for economic output. For example, the price of a barrel of Brent oil has fallen by nearly 11% over the past year.

“However, extreme valuations offer an attractive entry point into both Russian equities and local bonds. Russia does not have a solvency problem.  It is a net creditor exporting dollars and Russian issuers in general are supported by sound balance sheets. But debt investors are not paid to take the risk in the same way equity holders are, so we are happy to be underweight debt and overweight equities in the portfolio. It’s a good example of a market where the ability to combine strategic and tactical allocations creates opportunities for active managers.”

Titherington, who serves as Chief Investment Officer for Emerging Market Equities, focuses on fundamental stock selection with an emphasis on both growth and income.

China

Titherington continues:  “Given that growth challenges persist when we look at the economic slowdown in China, uncertainty remains.  Partly as a function of this uncertainty, valuations look attractive relative to their historical average and in absolute terms.”

“An area in which we have maintained conviction despite headwinds year-to-date has been the Chinese consumer discretionary sector, in which we’ve held several Macau casino operators.  Recovery in revenues and improving sentiment have contributed to a rebound and dividend yields remain between 5.5 and 6.5%, supporting our conviction.”

Adding perspective from an emerging markets debt perspective, Pierre-Yves Bareau comments that whilst there are limited debt securities available, he tends to favour the real estate sector for opportunities. Bareau, who serves as Chief Investment Officer for Emerging Markets Debt, notes that overall the asset class globally has maintained a strong run of performance year-to-date in 2014, with sovereign and corporate credit sectors outperforming. In his view, this has largely driven by well-anchored and range-bound developed market rates, which supported EM debt despite concurrent risks stemming from a busy political calendar and some geopolitical stresses.

Concluding on the benefits of combining emerging markets debt and emerging markets equity to generate both growth and income, Luparia states:

“Emerging markets represent not only an attractive source of long-term capital growth but an important tool in income-oriented portfolios. Emerging market debt has been sought for its higher yields, as well as for the fiscal strength of many issuers relative to their developed world peers. Meanwhile, with an increasing number of emerging market companies paying strong and rising dividends, emerging market equities have become a sustainable source of income. Combining the two asset classes allows investors to access a diversified stream of income and tap into emerging market growth, with lower volatility than an equity-only approach.”

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