I have historically not invested a lot in either Global or Emerging Markets stocks.
There is a place for both in the Protected Principal Retirement Strategy Portfolio.
In this article, I present my outlook for both global and emerging market stocks and evaluate a few CEFs that might fit the bill.
As a retired person who relies on dividends/distributions for a substantial portion of our income, I try to stick with sectors that I know. Global and/or emerging market stocks are close to the bottom of my comfort list; however, I realize that any well-rounded portfolio should include some of each. In the case of the Protected Principal Retirement Portfolio (PPRP), my target allocation for these sectors is about 15 percent (10 percent global equity and/or income and five percent in emerging markets).
At present, all of my global holdings are contained within a few closed-end funds (CEFs), and I hold no emerging market stocks. My near-term outlook for the markets has not changed - I still look for a fairly decent correction. Since I am not looking to add anything to the portfolio at the present time, it is an ideal time for me to catch up on foreign markets and share my outlook on things going forward.
Global and Emerging Markets
As I have mentioned in past articles, I am not a big believer in technical analysis, except for trend lines. Usually (not always), when a long-term trend line is substantially violated, the prior trend will reverse. With that in mind, let me discuss global and emerging markets index performance and trends over the past three to five years.
The FTSE All-World Index
The Financial Times Stock Exchange All-World Index is a composite of global stocks. It covers over 3,100 stocks in 47 countries and it goes back to 1986. The symbol is AW01-FSI. As of Oct. 7, the index stands at about 340. The index made a major top at 365 in February 2018 and a correction bottom of 295 in December 2018. Other than these extremes, it has trended around the 320-350 trading range. A long-term uptrend began at the 235 level around February 2016 and remains in place. A shorter-term downtrend began at the 365 level in February 2018, and there have been two attempts to break this trend since early summer of this year.
I would like to see this short-term downtrend line breached to the upside before committing funds to global stocks.
The MSCI Emerging Markets Index
The Morgan Stanley Capital International Emerging Markets Index. Since its inception in 1988, this index has expanded to 26 emerging market countries, which together represent 13 percent of global market capitalization. The symbol is MMEZ19.NYB. The index presently stands at 995, about where it was in late 2014. In early 2016, the index bottomed at 688 and a recent peak was reached in early 2018 at 1268. A long-term uptrend that began before 2014 remains in place while a shorter-term downtrend which began at the 2018 peak has contained the MSCI average. These converging trend lines will resolve in one direction or the other very soon.
Near-Term Expectations For World Markets
While the FTSE index remains comfortably above its long-term trend line, the MSCI index is dangerously close to breaking down.
As I have stated in prior articles, I am anticipating a correction in both domestic, global, and emerging markets in coming months. I have no idea nor will I speculate on how deep a correction we will experience if the correction will spill over into a full-blown bear market. I have prepared for this eventuality by raising cash over the past several months - to about the 25 percent level.
I also feel comfortable that I have the necessary time to get caught up on global and emerging markets research while I wait.
In the ensuing paragraphs, I will outline my strategy for adding global and emerging market positions to the PPRP and how I plan to go about implementing it.
The PPRP allocation to global and emerging markets position is presently 15 percent. I will be re-allocating at the beginning of 2020, so these percentages could change slightly. Two-thirds of this allocation are to be dedicated to global market (equity and/or income) positions and the remaining one third to emerging markets (equity and/or income) positions.
To fulfill these allocations, I have opted to use closed-end funds. The main reason is that with all of the other research that I do, I cannot see myself adding the time it will take me to delve into an analysis of individual stocks in many different countries. Besides, I am very familiar with CEFs and have developed my own criteria for evaluating them.
Although during my research I typically skip between sources, I will try to keep the information presented herein to metrics easily found on either the CEF's own website or on CEFConnect.
Global Equity and/or Income
I first ran a CEFConnect screen of all global equity and income funds. The result was 17 funds. Since I strive for yields in the seven to nine percent range, I was able to eliminate a few immediately. A new criterion that I am now incorporating into screens on CEFConnect is that I eliminate all CEFs whose returns since inception on both NAV and market price are less than approximately five percent. This further reduced the list to 10 funds. I have found that some "global" funds are more than 50 percent invested in U.S. stocks. Since my goal is to diversify the PPRP on a truly global basis, I also chose to eliminate those funds heavily weighted towards U.S. stocks. As a result of these preliminary screens, I arrived at six funds for further analysis: JH Hedged Equity and Income Fund (HEQ); MFS Charter Income (MCR); MFS Multimarket Income (MMT); Aberdeen Global Income (FCO); First Trust Aberdeen Global (FAM); and Aberdeen Asia-Pacific Income (FAX).
The next step is to apply the criteria I explain in a previous SA article (here), in order to further reduce the list to a few realistic candidates. Please understand that these are my criteria - you might have some of your own to add - I hope.
Using the CEF evaluative criteria, I can make the following conclusions about the six candidates mentioned above:
- HEQ and FAX have discounts that are quite close (but above) to their 52-week average discounts.
- Only HEQ does not use any leverage.
- MCR and MMT have the lowest fee structure.
- FAM has had a recent dividend increase, while MCR and MMT (with variable dividends) have dividends trending upward.
- Each of the six funds has a yield in excess of 7.8%.
- MCR (+21.5%), MMT (+23.6%), and FAM (+23.6%) have been the best market price performers year to date.
- Over the past 20 years, MCR, MMT, and FAX have had the most positive years in terms of market price, with 16, 16, and 14 up years, respectively.
- MMT and FAM have the lowest percentage of return of capital on their dividends.
- MCR and FAX are the only funds having a discount to fee ratio above 10.0x.
- From the standpoint of portfolio objectives, HEQ, FCO, and FAM have total return as an objective, with HEQ using an options strategy to increase the dividend.
Based on the criteria that I use for this analysis, I believe that MCR, MMT, and FAX are candidates for further research.
Emerging Markets Equity and/or Income
Employing a similar CEFConnect screen as used for global fund screening, I wound up with a total of 11 emerging markets funds. Only three of these met the criteria of generating greater than five percent returns since inception on both NAV and Market Price: Western Assets Emerging Markets Debt (EMD), BlackRock 2022 Global Income (BGIO), and Morgan Stanley Emerging Markets Debt (MSD). It should be noted that although BGIO is a CEF, it is also a trust type of fund.
Applying the same evaluative criteria as was done with global funds, the following conclusions were drawn:
- Only MSD's discount was close to its 52-week average discount; both of the others were somewhat higher.
- MSD's leverage (2 percent) was by far the lowest.
- BGIO's fee (0.94 percent) is the lowest of the three.
- All three funds have appreciated in market price by more than 17 percent year to date, with EMD leading the way at 21.4 percent.
- Both EMD and MSD have the best performance records over at least the past 16 years (EMD up 11 out of 16years and MSD up 17 out of 21 years). BGIO has only been in existence for two years.
- Only EMD includes return of capital in their dividend; however, it is only 10 percent, which I consider negligible.
- EMD has by far the highest yield, currently at 8.6%.
- MSD has the highest discount to fee ratio at 9.8x.
In my opinion, both EMD and MSD will warrant further examination in the coming weeks (or months).
To reiterate, in my opinion, market conditions do not, at this time warrant purchase of either global or emerging markets position for the PPRP. World markets are too shaky, and I believe that the longer that we go without a correction, the more severe it might be.
Further, I want to see how both the FTSE and MSCI indices resolve current trends.
In the interim, it is my intention to continue examining both global and emerging markets in hopes of possibly unearthing additional potential positions. Your suggestions are always welcome!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.