Despite the challenging backdrop for the sector, Nick Price, Portfolio Manager, Fidelity Emerging Markets Fund believes that there are still opportunities for discerning investors in emerging markets
In the face of heightened trade tensions, US dollar strength and a raft of news flow concerning the developing world, emerging market (EM) equities have struggled in recent times. Looking ahead, these factors and themes will likely continue to shape near-term sentiment towards EM assets. From a trade perspective, it is difficult to assess how US policy will ultimately play out although increased protectionism will negatively impact the global economy and not just EM.
US monetary policy and the strength of the dollar is another important consideration. However, EM governments are now far less reliant on external funding than in the late 1990s when we witnessed the Asian currency crisis.
While there are exceptions – see Turkey’s recent woes – the risk today is more apparent on the balance sheets of individual companies. Going forward it will be important to avoid companies with currency mismatches where a depreciating local currency will inflate the value of externally financed debt.
As ever in EM, domestic politics will likely continue to drive some volatility in the coming months. Already this year both Mexico and South Africa have seen new leaders emerge and Brazil has a general election scheduled for October. Investors will look closely at the next President’s willingness to undertake the necessary reforms to create lasting growth and reduce an unsustainable budget deficit. This will prove crucial in determining the direction in which the Brazilian economy will head.
Elsewhere, the prospect of US sanctions continues to hang over Russia. Whilst the outcome of the Sanctions Bill remains uncertain, markets will require a significant discount for holding Russian assets in the short-term. However, some companies have proved resilient; Lukoil is held in the Fidelity Emerging Markets Fund and has proven to be one such company. It is the second largest oil producer in Russia and the world’s second largest private oil producer, and exhibits an attractive dividend yield.
From a macro perspective, the Russian economy has been remarkably robust thanks in part to a higher oil price although the uncertain backdrop will likely weigh on sentiment towards its currency and equity market. Any new sanctions will require careful assessment to fully understand the implications for individual Russian companies.
New vs old China
In China, we continue to see many opportunities to invest in good quality businesses that are exposed to consumption, particularly in areas like autos and e-commerce. Beyond the consumer, China’s willingness to liberalise industries such as financial services is encouraging; creating an environment in which leading companies can expand their footprint in China.
The environment across China’s old economy is more nuanced. The government has been successful in executing a significant capacity reduction in areas such as steel and coal and there is scope for this to continue. The data points in the property market are more mixed. The extent to which the property sector is intrinsically linked to iron ore and steel demand is an important consideration (not only for China, but other key exporters such as Brazil and South Africa). However, the lack of real supply addition since the global financial crisis tempers those concerns.
India presses on with its reform agenda
Finally, a note should also be made on India. Here, Prime Minister Modi has made notable advancements in his reform agenda in the way of a goods and services tax, demonetisation and a bank recapitalisation program. Each one weighed on the economy to differing degrees, but the prospects of an improved fiscal base, a modernised (and less corrupt) monetary system and a more fundamentally sound banking system should benefit the country for years.
Demand for certain goods and services in India are still nascent. Banking is a case in point and provides an opportunity for companies to take advantage of India’s low credit to GDP. HDFC Bank remains a key position in the portfolio – it has an impeccable track record; having consistently delivered superior growth relative to the industry, whilst also maintaining the best asset quality across banks throughout different cycles.
Moreover, HDFC has excellent management and a very strong balance sheet. The bank has utilised free cash-flow to develop its branch network and embraced technological advancement; digitising its business to enable more straight through processing and drive efficiencies, without diluting risk parameters. Importantly, as the challenges in state-owned enterprises persist, private banks like HDFC are in an ideal position to gain market share.
We also maintain exposure to Housing Development Financial Corp, a prudent mortgage lender with solid expertise in underwriting.
Modi’s focus on ‘housing for all’ aims to bring affordable homes to many and provides a supportive backdrop for the company to continue delivering solid loan growth.
While the long-term outlook for India remains very constructive, a nearterm risk to monitor is the potential for dollar strength to result in sustained rupee weakness with higher inflation hastening a series of rate hikes. However, like all holdings in the portfolio, we remain positive that our Indian exposure is appropriate and capable of delivering investors an attractive total shareholder return.
About Nick Price
Nick joined Fidelity in January 1998 as a research analyst. In 2005, he led the development of Fidelity’s EMEA group. Supported by a growing emerging markets team of analysts and portfolio managers, Nick was appointed to manage Fidelity’s global emerging markets equity products in July 2009. Nick holds a Bachelor of Commerce and Diploma in Accounting from the University of Natal and is a Member of the South African Institute of Chartered Accountants and a CFA Charterholder.
This article is for investment professionals only and should not be relied upon by private investors. The value of investments can go down as well as up so the client may get back less than they invest. Past performance is not a reliable indicator of future returns. The Fidelity Emerging Markets Fund has, or is likely to have, high volatility owing to its portfolio composition or the portfolio management techniques. It can use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. As the fund invests in overseas markets, the value of investments can be affected by changes in currency exchange rates. Investments in emerging markets can also 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. Please note that the views expressed may no longer be current and may have already been acted upon. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document and annual and semi-annual reports, free of charge on request by calling 0800 368 1732. Issued by Financial Administration Services Limited and FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. UKM0918/22450/SSO/NA.