Barings Emerging EMEA Opportunities 24 June 2020

Baring Emerging Europe (BEE) aims to generate strong total returns – latterly with a substantial contribution from dividends – by investing in emerging European equities. In practice this means Russia, Poland and Turkey, which together make up almost 90% of the MSCI Emerging Markets Europe 10/40 benchmark.

Manager Matthias Siller has a strong track record of alpha generation, with the trust being in the top quartile of emerging market trusts for alpha and Sharpe ratio, as we discuss in the Performance section.

Absolute performance has been strong in recent years as the Russian market has generated strong returns thanks to the recovery from the 2014 recession and improving corporate governance. This has supported rising payout ratios which have helped BEE generate a significant yield, now 5.3% on a historical basis.

The board has paid more attention to dividends since 2016, when it committed to paying up to 1% of NAV from capital to support the payout if necessary. This gives the board flexibility to make up for any decline in earnings thanks to the current pandemic, although we note that the dividend was fully covered by earnings last year.

Medically and economically, emerging Europe has coped relatively well with the crisis, although falls in currency have exacerbated modest declines in equities measured in local currencies. Matthias tells us the low levels of government, corporate and household debt give the region good prospects if the current recovery continues.

The trust trades on a discount of 12.6%, with an active buy-back policy and a possible 25% tender vote following the end of the financial year in September (see the Discount section).

Emerging Europe is a relatively little-owned region, but has much to offer investors in emerging markets or in developed Europe. Such high dividend yields are hard to find in developed Europe, and may become harder thanks to the impact of the coronavirus crisis. Meanwhile the region is much cheaper than the North Asian countries which dominate the mainstream emerging-market funds (the benchmark’s P/E is just 7.6 times, compared to 14 times for the MSCI All China Index).

Improving corporate governance and dollar earnings mean that Russian corporates in particular are highly cash-generative, and having been through numerous crises in recent years have strong balance sheets. This should bode well as long as the current recovery continues. Recent market declines have a significant currency component to them, which adds to the value proposition, as does BEE’s discount.

As we discuss in the Dividend section, BEE also has flexibility with regards to its dividend. The ability to pay up to 1% of NAV from capital gives the board the ability to offset at least some of any reduction in earnings which the pandemic causes this year. Despite the strong returns in recent years, the cheap valuations and strong fundamentals in its markets make BEE an interesting recovery play, with manager Matthias Siller’s strong track record of generating alpha a bonus.