JPMorgan Asian aims to produce long-term total returns by using its extensive research capacity in Asia to generate alpha from stock-picking. The managers, Ayaz Ebrahim, Richard Titherington and Robert Lloyd, believe that it is earnings growth and dividends which determine returns in the long run, and so the process is heavy on fundamental research and designed to look through macro-economic issues to the potential in the stocks below.
The process has been proven to work in recent years, with the trust outperforming in each calendar year since 2015, with the bulk of the alpha coming from stock selection. In particular, stock picking in China has been key, and JPMorgan have invested heavily in this area to facilitate this, and continue to build out their research capability in the local A-Shares market, which is increasingly being absorbed into the global financial system.
Although the managers bear ultimate responsibility for selecting the stocks, the process depends less on one or a few people making right calls consistently, but more on a wide, experienced team implementing a sound strategy consistently.
The trust has no gearing at the moment, reflecting the manager’s views on the valuation of the market. In fact, it has not been geared since the start of 2017, making the outperformance in the sharp market rally of 2017 especially noteworthy. This cautious positioning helped the trust outperform in the down market of 2018, although we understand it would take a significant shift down in valuations for gearing to be taken out.
The trust pays out 1% of NAV each quarter as a dividend, paying from capital as necessary. The implementation of this policy in 2016 led to the discount narrowing significantly, and the trust now trades on a 7.7% discount, having tended to trade above 10% prior to the policy change. The yield on the current share price is 4.2%.
The OCF of 0.75% is the cheapest of the five trusts in the AIC’s new Asia Pacific Income sector, despite the fact the trust is not the biggest – meaning the lower costs are not just a result of economies of scale. The management fee is charged on market cap, not NAV, which gives the manager an incentive to close the discount further.
The track record of the trust since the Asian and Emerging Markets analyst teams were combined in 2016 has been excellent, and it is impressive that the outperformance has come with limited gearing in 2016 and none in the rally of 2017. We think the disciplined approach to stock selection and market analysis is a key advantage, all based off the extensive resources that JPMorgan can apply to both areas. In particular, we are wary of trying to time the markets in the current macro-economic environment – it is hard to read the US economy, US policy and the future of the confrontation with China, all of which are crucial to the short-term market movements in Asia.
JPMorgan Asian’s process is designed to cut through these unpredictable factors to the real long-term drivers of company performance: earnings and dividend growth. We also take comfort from the fact that the current positioning of the trust is more exposed to domestic Asian growth than the sectors troubled by the trade war with the US. In all we think this trust is an excellent core long-term play in the region, and could also suit those who are more cautious on the immediate prospects for Asia, wanting exposure to a high quality team but to take the edge of market exposure.
|A track record of excellent stock-picking backed by insights from an on-the -ground research team
||The dividend is likely to fluctuate given it depends on NAV not income
|A discount wider than the average of peers despite strong NAV performance
||Gearing has always been conservative, which could hold the trust back in rising markets
|A 4% dividend yield paid from capital and not provisional on portfolio income
||China is over a third of the benchmark, so investors take some single country risk
JPMorgan Asian aims to produce long-term total returns by using its extensive research capacity in Asia to generate alpha from stock-picking. The managers, Ayaz Ebrahim, Richard Titherington and Robert Lloyd, draw on the research of a huge team of 36 analysts based across the region, each working to the same research framework intended to identify the most attractive stocks in their sector or country of expertise.
The managers believe that it is earnings growth and dividends which determine returns in the long run, and so the process is heavy on fundamental research and designed to look through macro-economic issues to the potential in the stocks below (a highly attractive approach in the current volatile political environment, in our view). Central to this being successful is the strength of the analyst team and process. JPMorgan have invested heavily in the research team over the years, and continue to do so, with the team being made up of individuals whose ambitions are to be career analysts rather than move into a fund management role.
Three years ago, JPMorgan brought together the Asian and Emerging Markets analyst teams, with one driving factor being the increased importance of China to both indices (as we note in the performance section, the trust has outperformed in each year since the teams were united). JPMorgan has been at the forefront of the expansion of asset management firms into that country as it opens up, and this has helped it to add significant value through stock selection in that country. The most recent additions in the team have been focused on the domestic China A-Share market, and two of these new analysts are working from a new Shanghai office. This is an opportune time to be expanding an analyst team given that sell-side firms are reducing headcount in the light of MiFID regulations, and JPMorgan has been able to take advantage of this.
The output of the bottom-up heavy process is a portfolio which has generated excess returns against the index in all of the past five calendar years, with the alpha coming from the stocks selected. Stock picks in China have been particularly significant, as the resources JPMorgan can bring to bear there have given the trust an advantage as the market has boomed and opened up to the outside investment community.
The trust has a slight bias to growth over value, based on Morningstar style analysis, although the portfolio is fairly well balanced, with the highest weighting being to core stocks. This makes sense as there is no specific style bias to the investment process, but the analysts are asked to produce five-year return expectations for their stocks, based on expected earnings growth, valuation changes and dividends and rank those in their area of expertise. The focus of their fundamental research is on three main topics: economics – does the company produce good returns for shareholders, duration – can those returns be sustained in the future, and governance – will those returns accrue to shareholders in full or be impaired by poor governance.
Rather than thinking in terms of country and sector weights, the managers aim to identify stocks which fit in three main silos. First, they look for core franchises, which are the long-term compounders which they expect to hold for over three years (and are typically larger positions). Secondly, they aim to find what they consider “growth stocks”, which are those companies they expect to experience accelerated growth in the short to medium term, typically one to three years. Finally, the company also owns cyclical stocks or restructuring stories with a short-term catalyst, which they expect to exit in 12 to 18 months. It is in this latter bucket which most expresses the managers’ views on the economic cycle and valuations, with stock-picking in the other two silos, by far the bulk of the portfolio, almost entirely dependent on stock specific factors.
||Cyclical / Restructuring
|Expected Holding Period
||1 to 3 years
||12 to 18 months
||1% to 3%
||1% to 2%
||0.5% to 1.5%
Given the focus on stock selection and the above schema, the trust tends not to be highly active with respect to country weights. Currently the largest overweights are to Korea, Indonesia and an off-benchmark position in Vietnam. The average active weight is just 1.5 percentage points, however. The trust is underweight China, although many of its highest conviction picks are in that country – the insurers AIA and Ping An, for example. The managers believe there is still huge potential in these companies thanks to the growth of the middle class in China creating extra demand for financial products, particularly given the limited provision of social security in the country.
The trust does tend to be more active with respect to sectors – currently it is six percentage points overweight financials, for example. However, the average active weight is still below two percentage points.
Having said that stock-picking dominates, there is some input from top-down analysis. The team run quantitative models on the countries in the region, looking at the valuation of their stock markets, currencies, the state of their politics and position in the business cycle. Expected returns from the markets are also calculated, as with the stocks. This plays into the country weights, in that it encourages the managers to pick more stocks from the favourably graded markets and weight them more highly. However, in the two core silos of compounders and growth stocks, the long-term horizon means that the country views are of less relevance to the weightings – they come into play more with the cyclical / restructuring stocks. The macro valuations models also come into play when considering the gearing, and are the major reason why the trust has not been geared since the start of 2017. This is only likely to change when the models show significant value across the market, likely after a major sell off or turning of the cycle.
|China Construction Bank
Source: JPMorgan, As at 31.05.19
There are advantages to this regimented approach to stock analysis and macro-economic analysis, we think. Although the managers bear ultimate responsibility for selecting the stocks, the process depends less on one or a few people making right calls consistently, but more on a wide, experienced team implementing a sound strategy consistently, which is far more reliable in our view. In the current market environment this is particularly appealing. With politics in the US and China increasingly important to the course of Asian and global markets, having a process which cuts through these binary and unpredictable factors to look at stock fundamentals, and to a lesser extent economic fundamentals, in a disciplined way is likely to lead to clearer-headed stock picking with a good chance of long-term success, in our view.
The board has given the manager discretion to borrow up to 20% of NAV, and they have facilities in place to do this. However, the trust is not geared at the moment, and hasn’t been since the start of 2017.
This is because the managers use valuation signals from their macro models to decide when to gear, and following the rally in 2016 these models no longer indicated extreme levels of valuation. Given the strong returns in Asia in 2017 this was arguably a missed opportunity, but the downside of sticking to a valuation discipline is missing potential returns from the frothiest markets, and having a net cash position helped the manager outperform in the weak markets in 2018.
It is also notable that the trust outperformed in NAV terms in 2017 without being geared. The managers anticipate this will remain true while Asian equities are trading above average valuations.
The trust has handsomely outperformed the index and peer group over five years thanks to strong performance in each completed calendar year since 2015, when JP Morgan merged the Emerging Markets and Asia Pacific equity teams. The trust has made 92.5% in NAV total return terms, while the share price has more than doubled, returning 102%. Over this period, the average return from the Asia Pacific ex Japan trusts tracked by Morningstar was just 64.1% in NAV total return terms, while the index made marginally more – 64.8%.
The trust has outperformed the index in each year since 2015, in both rising and falling markets. It has also beaten the peer group average each year except for 2016, when it lagged by less than 1% in a sharply rising market. In fact, the trust has the best NAV returns of any open or closed ended Asia Pacific ex Japan fund over three years bar one (the open-ended JPM Asia Growth). Over 2019 so far it is ahead of the index but behind the peer group by less than 1%.
The team aim to generate their edge from stock-picking rather than superior market timing, which we applaud as the latter is notoriously difficult to do – particularly in a macro-economic environment such as today’s, when so much depends on politics. This is borne out in the numbers, as the trust has tended to generate its alpha from stock picking rather than country or industry selection. In 2017, for example, picks in financials, healthcare and technology boosted the trust relative to peers and the index, while stock selection was particularly strong in China, which is some evidence that the resources allocated to that country by JP Morgan are bearing fruit. Good stock picks continued to drive the fund’s returns in 2018, in particular, stock selection in South Korea (Samsung, Daewoo) and China (Sino Biopharmaceutical[sold in the summer] Shenzhou, Ping An).
Over the past year, the trust has outperformed the index in NAV total return terms, although it has been in line with the peer group average. Most of the outperformance came in the falling markets of Q4 2018. Over the year to the end of April 2019, the top contributors were Wuxi Biologics (China), Ping An (China) and Jiangsu Hengrui Medicine (China). Seven of the top ten most successful picks were China listed, one is listed in Hong Kong and the other two in Taiwan. The team believe their portfolio is not very exposed to the trade war which has been behind the worse periods for the Asian markets over the past year, but more exposed to domestic Asian growth. The lack of gearing (the trust has had no debt since the start of 2017) helped relative to peers in the falling markets too, although stock picking has been enough to outperform on the upside without the tailwind of leverage.
ONE-YEAR RELATIVE PERFORMANCE
The trust pays a dividend of 1% of NAV at the end of each quarter, absent unforeseen circumstances, having adopted this policy in October 2016. As a result, the dividends rocketed from 3p in 2016 to 13.9p in 2017, and 15.7p in 2018, and the trust is now an option for income-seeking investors as well as those looking for long-term capital growth. The dividend can be paid from capital and has been since 2017: revenue was only 28% of the 2017 dividend and 35% of the 2018 payout. Despite the new dividend policy, the manager’s objective remains maximising total returns.
The strategy is run by the Emerging Markets and Asia Pacific (EMAP) equities team at JPM. Ayaz Ebrahim and Richard Titherington were joined as named managers in August 2018 by Robert Lloyd. Ayaz and Richard work together on the top-down analysis and asset allocation, while Ayaz manages the Trust on a day-to-day basis and leads on the stock selection. Richard has been with JPM for three decades and Ayaz joined in 2015 from Amundi; he heads up the Asia Pacific asset allocation committee. Robert, with 12 years’ experience with JPMorgan, has run Asian portfolios since 2014 and manages several Asian regional portfolios together with Ayaz. His addition bolsters team resources particularly in stock selection. The managers can call on both research analysts and country specialist PMs for insights.
The core of the strategy is the extensive analyst team at JPM. Stock analysis and ideas come from both sector specialists, who tend to focus on the large caps in their industries, and product analysts, who are focused on small to mid cap companies by geographies. As discussed above, JPM has made large efforts to expand their coverage within China, and 12 of the overall research platform are dedicated to covering the Greater China region. A Shanghai office operating under a Wholly Foreign Owned Enterprise license since late 2016 is staffed with two analysts already, with more potentially to come.
In our last note in December we highlighted the double-digit discount to NAV and lower rating than the sector as being unjustified given the strong track record of the trust. In the first quarter of the year the discount came in strongly, to briefly trade tighter than the sector below 5%. Since then, as global stock markets have been weaker, the discount has come out slightly again, although it remains below the 10% it was in December at 7.7%.
Total return performance has been strong, with the trust outperforming in the down year of 2018 after outperforming in the rally of 2016 and 2017, and this appears to have been recognised in the narrowing discount. The 2016 dividend policy has also helped the trust trade tighter than it historically has – there was a marked shift from a 10-15% range to a band around 10% after the trust committed to paying out 1% of NAV a quarter in a dividend from the 2017 financial year.
The board has buyback authority but, given the effectiveness of the dividend policy, has not used it since early 2017. The board views 10% as the upper range of acceptable, beyond which it might use buybacks.
The OCF on the trust is 0.75%, making it the cheapest of the five Asia Pacific ex Japan Income trust, according to JPM Cazenove stats. It is notable that the trust is cheaper than three which are larger than it, meaning the lower charges are not due to economies of scale. The cost includes a management fee of 0.6% of market cap, taken as the average of the past three month-end figures. Using market cap rather than NAV gives the manager an incentive to see the trust not trade on a discount. The KID RIY is 1.33%.