2 Income Opportunities in Emerging Markets

01/12/2011 1:40 pm EST

Focus: GLOBAL

Andrew McHattie

Editor, Investment Trust Newsletter

Two London-listed trusts are mining the volatile space for 4% yields in addition to capital gains, writes Andrew McHattie in Investment Trust Newsletter.

JPMorgan Global Emerging Markets Income Trust (London: JEMI) was launched in July, and has made a decent start, rising from 100 pence to 118.50 pence. In capital terms it has lagged the best performers, but that is to be expected as it is targeting a 4 pence annual dividend.

Manager Richard Titherington recently confirmed the trust has been fully invested since launch and is currently operating with a modest level of gearing. “I’m not a big fan of gearing, but we can borrow US dollars for less than 3.5% and then get 5%-6% dividend yield from equities—what’s not to like about that,” he said.

Key holdings include Petrochina (NYSE: PTR), African Bank Investments (OTC: AFRVY), HTC (Taipei: 2498), KT&G (Seoul: 033780), and Quanta Computer (OTC: QUCPF, Taipei: 2382). The portfolio has a mid-cap bias that Titherington calls the “sweet spot,” offering a good combination of sustainability and value. He thinks emerging markets equities are fairly valued at current levels, and in line with long-term averages.

For cautious investors wanting exposure to emerging markets, but also wanting the discipline of a dividend and a more value-oriented approach we can see the merits of this trust. It is never likely to provide leading capital returns, but in its short life to date has already demonstrated how some capital gains might combine with its dividends to provide solid returns.

A Bet on Brazil Bonds
Launched just after the JPMorgan trust, in August, Aberdeen Latin American Income Fund (London: ALAI) has also made reasonable progress. The shares have risen from 100 pence at launch to 113.50 pence now. Manager Devan Kaloo says that this trust “is a fairly unique product” because it seeks to derive its returns from a mix of equities and debt. We would agree that the blended portfolio of equities and sovereign bonds is a significant differentiating factor.

The managers aim to generate around 4.3% in yield from their portfolio, but their objective is actually one of total return, so capital is certainly not ignored. Aberdeen reckons the long-term outlook for Latin America remains compelling. Levels of corporate debt have been falling, profitability has improved, dividend payouts are increasing, and ratings remain attractive. On the debt side, Aberdeen argues that local currency sovereign debt markets offer highly attractive yields, with substantial scope for a rerating. “There is still in our view a massive mispricing,” says Kaloo. The real (after inflation) yield on Brazilian local currency bonds is 7.3%, he notes, massively outstripping the returns available from developed countries.

For Kaloo, there is a clear mismatch between perception and reality in Latin America. With the notable exception of Venezuela, the politics of the region are stable, he says. Inflation is no longer a significant issue, and the Latin American economies are not massively dependent on commodities or US interest rates. Governments in the region have used the commodity boom well, paying down external debts and managing their fiscal policies conservatively.

“Latin America is not cheap in relation to developed countries, but it does offer better return on equity and growth,” Kaloo says. The managers feel no pressure to deliver too much in the way of yields from the equity component, as the bonds are expected to provide much of the income. The trust’s equity holdings focus on growth orientated stocks, aiming to deliver capital appreciation as well as yield. At the end of October, around two thirds of the portfolio was invested in equities, plus a further 40% in fixed income. Eagle eyed readers will notice that adds up to more than 100%: the extra is accounted for by the trust’s gearing, which is currently running at just under 10%. The trust’s big bet is on Brazilian bonds, where it is strongly overweight. The equity holdings are very focused on consumer stocks, where the managers see long-term growth.

[For another emerging markets income play, check out Yiannis Mostrous’ recent recommendation of China Mobile (NYSE: CHL)—Editor.]

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