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Focusing in on emerging markets

Nick Price

Nick Price - Portfolio Manager, Fidelity Emerging Markets Fund

Emerging markets (EM) have enjoyed a strong run over recent months. While there has been ongoing uncertainty around US-China trade relations, EM equities have benefitted from a more favourable policy stance from the Fed which has buoyed investor sentiment and helped reduce upward pressure on the US dollar.

Focusing in on emerging markets

Given our prudent quality growth approach, it has been particularly pleasing that the Fidelity Emerging Markets Fund has outperformed the index recently in a strongly rising market.

Much of this has been driven by some strong stock selection in China and India. After a challenging 2018, at an aggregate level we have been encouraged by the strong recovery in the China A-share market with Inner Mongolia Yili and Kweichow Moutai standout performers. The pan-Asian insurer AIA Group also had another strong quarter as the financial sector benefitted from China’s announcement that it would lift the cap on foreign ownership of securities, futures and insurance firms in 2020.

In India, markets welcomed the election result in May and Prime Minister Modi’s National Democratic Alliance (NDA) decisive victory. The largest contributors to relative performance were HDFC Bank and Housing Development Finance Corp.

Outlook and positioning

Trade issues are expected to dominate headlines and drive investor sentiment over the coming months. A re-escalation of trade tensions that impacts the global GDP outlook has ramifications for the asset class. Conversely, a dovish Fed has scope to lend continued support to the asset class.

The health of the Chinese economy is also a key consideration. The announcement of further tariffs can have considerable repercussions for local companies as well as the broader economy. Economic stimulus measures and progress in negotiations will be pivotal in determining the trajectory of the Chinese economy over the second half of the year.

This will also have knock-on implications for the global economy, particularly in commodities which play a critical role in emerging markets. For example, a weaker Chinese economy, can translate into lower demand for crude oil. Similarly, infrastructure spend and property completions in China will be a key determinant of demand for copper during the rest of the year.

The long-term outlook for the asset class remains well supported, underpinned by multiple structural drivers such as favourable demographics, the rise of the consumer society, lower debt burdens and the natural resource advantage. Notably, the valuation picture also remains relatively attractive. Despite the significant gains we’ve seen over recent month, EM equities continue to trade at a large discount compared to developed market equities, hovering around -20%.

At the company level, we remain focused on identifying good quality companies, which can deliver attractive shareholder returns over the medium to long-term. Businesses that are market leaders in their respective segments and that can deliver sustainable earnings and cash flow remain the most compelling investment ideas.

The consumer opportunity

While country and sector allocation is driven by bottom-up stock selection, we continue to find significant potential in areas related to how and what an increasingly affluent population consumes. While this is evident across a range of markets, it is most notable in China where we have holdings across a range of areas such as dairy (Inner Mongolia Yili and China Mengniu Dairy), white goods (Midea Group), sportswear (Anta Sports), beverages (Kweichow Moutai) and autos (Zhongsheng Group). These are all companies with strong business models and fundamentals, set to benefit from a still persistent premiumisation trend. Here we place careful emphasis on selecting best in class companies which can weather a tougher economic backdrop.

Financials also remains a key area of focus. Unlike the developed world, many individuals across EM are at the very early stages of seeking products such as bank accounts, loans and insurance products. This gives providers access to a customer base capable of dwarfing that of which we’ve seen in the developed world.

In most markets, rates are nowhere near the lower bound that would threaten banks’ profitability. This means that any fall in rates should translate in greater credit growth, less loan default, and also higher multiples attached on a bank’s earnings stream. These factors more than offset the negatives on margins.

Our focus remains on banks with excess capital and conservatively managed balance sheets. This enables them to self-fund loan growth should it accelerate, and it also protects them if something goes wrong.

As a long-standing holding, Russia’s Sberbank is a good example in this regard. The Russian market has rallied over recent months as investors scoured for cheap and relatively trade war insulated pockets. Whilst the risk of sanctions remains, suppressing valuations, macro conditions are in an optimal state, with the country continuing to exhibit strong fiscal and current accounts. Moreover, its foreign-exchange reserves are sufficiently large to cover its total external debt.

Sberbank is set to continue benefitting from strong loan growth in the country and from expanding margins as loan repricing catches up with the two rate hikes in 2018. The stock continues to trade on one of the cheapest absolute multiples within EM Financials, despite one of the highest return on equity (ROE), with the added benefits of a particularly attractive dividend.

Other financials holdings include several insurers and we have recently moved to increase exposure to the Indian insurance sector. It represents a large structural opportunity as it offers a large runway for growth driven by under-penetration and scope for market share gains from state-owned enterprises.

HDFC Life Insurance is the best run life insurance company in India with a solid management team. It has the most balanced product portfolio, making its growth less vulnerable to sharp market corrections. ICICI Lombard General Insurance is a low-cost player with a solid brand, prudent risk management and good solvency, which makes it well places to capture the growth opportunities offered by the Indian insurance market.

More on Fidelity Emerging Markets Fund

Five year performance

(%)
As at 31 July
2014-2015 2015-2016 2016-2017 2017-2018 2018-2019
Fidelity Emerging Markets Fund 2.4 19.0 20.9 3.4 11.1
MSCI Emerging Markets Index -6.5 16.4 25.5 4.7 4.6

Past performance is not a reliable indicator of future returns

Source: Morningstar, as at 31.7.19, bid to bid, income reinvested in GBP. The fund’s primary share class according to the IA is shown.

Important information The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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