The diversity of emerging market companies is staggering. The MSCI Emerging Markets Index includes 1,330 companies across 24 countries, ranging from some of the biggest enterprises in the world to small domestic players. The businesses range from highly cyclical to high growth with valuations that can be attractive or extremely expensive.

Making investment decisions in a notoriously volatile asset class such as emerging markets requires a strong, consistent process that focuses on high-conviction, long-term winners. The portfolio managers of JPMorgan Emerging Markets Investment Trust plc (JMG) aim to select the highest-quality businesses across the emerging markets and buy them at prices that allow for upside over time.

This investment process has generated strong returns for the trust over the last 10 years, but will naturally suffer periods of short-term underperformance. A closer look at the recent market environment helps explain JMG’s recent performance and its positioning to deliver future returns to its shareholders.

Staying disciplined in India’s bull market

India’s strong economic growth has lifted many businesses and fuelled a historic bull market. JMG has been well positioned for the rally in Indian stocks: India is one of the largest country overweights in the trust and the Indian companies owned in the portfolio have performed well.

However, the trust has not owned several lower quality, highly valued banking stocks that are in the benchmark and have performed very well this year. This positioning has accounted for the majority of JMG’s underperformance vs. the MSCI Emerging Markets Index so far in 2024. JMG’s portfolio managers seek high-quality businesses at attractive valuations because these companies tend to be able to weather challenging environments while also participating in stronger markets. Similarly, the portfolio managers tend to avoid lower-quality companies because these businesses are more vulnerable when the economic cycle or stock market turns down, leading to underperformance.

Currently, India’ strong economy and bull market is benefiting many kinds of businesses—companies with stressed balance sheets are starting to show some improvement and highly cyclical businesses are posting stronger earnings. Even stocks of companies facing regulatory uncertainty or with corporate governance issues are getting a lift. JMG’s portfolio managers do not expect these kinds of stocks to outperform over the long term but recent strong returns have been a headwind for JMG’s relative performance.

Some of the Indian stocks that recently outperformed are indeed high-quality companies but have very high valuations—in some cases, a price-to-earnings (P/E) ratio of 100x. JMG does not typically own stocks at this valuation level because the portfolio managers cannot find realistic risk/reward scenarios to support the case for investment. For context, the forward P/E for the MSCI Emerging Market Index is roughly 20x-25x, which is already high relative to history and has often preceded a period of weaker market returns. The portfolio managers believe current valuations are pricing in only the very best-case scenarios for these companies. They offer little or no upside as they grow into their lofty valuations, while also coming with significant downside risk if that best case does not materialise. 

Diversifying further out of China

China has been one of the largest country underweights for JMG, which has been helpful for relative performance. Recognising the continued challenges in China’s economy, the portfolio managers have recently exited a number of small positions in Chinese stocks—seven of nine companies recently sold were based in China. The portfolio managers have been finding a wide variety of new investment candidates elsewhere, and have used the proceeds to fund seven new positions across seven different country markets. A few of these are smaller cap companies, where exciting new opportunities are now being found.

Overall, the trust’s sector and market positioning has remained relatively stable. The portfolio managers still find the most opportunities in the consumer, financials, technology sectors and remain underweight the energy and materials sectors, which have many cyclical stocks.

From a country standpoint, JMG is most overweight to Hong Kong, Argentina and India compared to the benchmark and is most underweight China, South Korea and Saudi Arabia.