Emerging markets are quickly changing and highly diverse; the JPMorgan Emerging Markets Investment Trust takes the opposite approach.
The Trust’s long-term returns – almost double those of the MSCI Emerging Markets Index over the past 10 years – are driven by a high-quality, long-term approach to stock selection. This process results in a portfolio with exceptionally low turnover – typically under 10% – and focused positions across key sectors and countries: 90% of the portfolio is invested in companies broadly related to technology and communications, the consumer and financial services while over 50% in invested in China, India and Taiwan.
This same focused investment process and portfolio also helped the Trust beat its benchmark during the extreme market conditions in 2020 and 2021: the lows of the pandemic and the sharp rebound of the recovery. How did a portfolio of stocks selected for the long-term also fare well in volatile short-term environments?
High-quality companies with sustainable growth
It starts with clear focus on finding businesses that can create true economic value over time through sustainable business models, competitive positions and good governance. The companies in the portfolio have an average return on equity (ROE), a measure of profitability, that is significantly above that of the broader MSCI Emerging Markets Index. Importantly, they have achieved this profitability with low leverage: on average, they have a net cash position, which compares favourably to the average net debt-to-equity ratio of 26% for the benchmark and means they have more financial flexibility.
The kinds of companies with these characteristics – profitable business models, strong balance sheets and sustainable long-term growth – tend to cluster in certain industries and sectors.
Technology is a good example. Many technology-related companies play directly into the massive global trend of digitisation, which is changing the way business is done in industries as diverse as healthcare, auto manufacturing and retail. That’s opening new and growing markets for technology companies and gives them strong long-term growth prospects. Many of these companies also have asset-light business models, meaning they tend to have low fixed costs and high free cash flow, which makes them attractive investments.
As a result, roughly 40% of the Trust is invested in technology and communications services companies. While that may at first appear concentrated, it is well diversified through the types of companies owned – from semiconductor manufacturers to IT service consultants and software developers, and through the locations where the companies are based, such as Taiwan, India and China, to name a few.
Businesses related to financial services and the consumer also tend to offer more compelling opportunities, largely for similar reasons: many companies in these sectors have asset-light business models and have exposure to long, secular growth trends, such as rising incomes and consumer spending across the emerging markets. As with technology, the Trust is highly exposed to these sectors – almost a quarter of the portfolio is invested in each – but in an equally diversified fashion.
Secular vs cyclical
With the vast majority of the Trust’s holdings in companies related to technology, financial services and the consumer, there are few or no investments across some other sectors. These tend to be asset-heavy businesses that are often related to energy and commodity production, utilities or real estate. Companies in these sectors often have more debt, more intervention from the government and high exposure to commodity price fluctuation. The portfolio managers don’t find these businesses attractive and the Trust has almost no exposure to them.
The focus on businesses with sustainable growth results in a portfolio with a structural bias towards industries exposed to strong secular growth and away from more cyclical sectors. This positioning has helped the portfolio’s long-term performance and was beneficial during the early stages of the pandemic, as business activity, consumption and social interaction moved online at a pace never imagined and exposed the urgent need for digital upgrades in almost all sectors of the economy. At the same time, commodity prices plummeted on the fall-off in global demand during lockdowns.
As global vaccination campaigns got underway, investors focused on recovering demand, sparking a rally in commodity prices and cyclical stocks. However, even with this notable headwind, the Trust still outperformed its benchmark in 2021 (through 31 October) due to stock selection, a testament to the enduring strength of the individual companies it owns. For example, despite pressures on the technology sector, the Trust’s holdings in several IT outsourcing companies were large positive contributors to performance; similarly, not owning a poorly performing technology company with a large weight in the benchmark also boosted relative returns.
Focus on the really long term
A few of the positions the Trust owns have now been in the portfolio for two decades already. The portfolio managers believe that great businesses should be owned as long as possible, unless the valuation becomes so extreme compared to all other choices. The stronger the business, the higher the valuation the managers are willing to accept. Those rare companies whose competitive position endures for a very long time, and which are also able to keep growing, represent the core of the portfolio for the simple reason that they still offer some of the best combinations of risk and reward available anywhere.