Casting our net wide
An uncertain backdrop has led to market volatility and a dramatic derating in the emerging markets complex. Fidelity Emerging Markets Limited (LON:FEML) Fund portfolio manager Nick Price however highlights that all emerging markets are not homogeneous and there are opportunities to be found in areas of the market where the risks are less pronounced and where valuation support is evident.
- It is easy to become fixated on the past and forget that the market is a forward discounting mechanism; we are of the view that a lot is already reflected in the price following a period of derating.
- Stock picking remains at the heart of our approach. However, given more pronounced country risks, we have increasingly supplemented traditional sources of research with a wider range of geopolitical views – which will continue.
- We have been active in repositioning; reducing where there are cyclical headwinds, and adding where the prevailing environment, combined with robust corporate fundamentals is favourable.
It has been a challenging year for emerging markets (EM) against the backdrop of inflation, geopolitical tensions and slowing growth, and we expect these factors to persist into the new year. The asset class has derated significantly, particularly when compared to developed markets. Earnings downgrades in certain industries will come, and some companies will be particularly vulnerable to higher costs, recession, and potentially punitive sanctions. However, it’s easy to become fixated on the past and forget that the market is a forward discounting mechanism; we are of the view that a lot is already reflected in the price.
As a risk asset EM has undoubtedly been punished, however, many EMs have made strides versus previous crises such as the 2013 ‘taper tantrum’. At the country level, the finances of some the most vulnerable economies have been shored up, inflationary pressures have been less pronounced, and where necessary we have witnessed the building of reserves and arguably the most proactive central bank policy moves in the world.
Where fears have been most acute, we benefit from solid valuation support and attractive entry points, amongst companies capable of generating robust total shareholder returns on a forward-looking basis.
What could surprise markets in 2023?
China has been highly topical, not least because as the largest single market in our universe it plays a central role in driving sentiment towards the asset class and performance of the index in aggregate. The market has derated to multi-year lows against a backdrop of policy developments which will continue to evolve. Whilst we are cautious, these are cyclical issues which will be overcome. In 2023 market participants will need to be vigilant and judge how the situation is evolving – a change in sentiment has scope to influence returns significantly.
Positioning for what lies ahead in 2023
We are confident that financials have potential to be advantaged in the current environment given their cheap valuations and decent dividend yield. Where interest rate rises have been aggressive, they benefit and if rates start to fall the thesis does not unravel. Whilst we believe we are nearer to the end of the rate rising cycle – rates are likely to remain higher than the preceding 5 years which benefits net interest margins for overcapitalised deposit heavy banks.
More broadly, Latin America has just completed an election cycle; with a clear move to the left across the region, it’s important to be vigilant about the risks that populist policies can pose to corporate activity, as governments seek out means to bolster public finances and appease the masses by introducing taxes and legislation which can be to the detriment of shareholders. That said, now voting has concluded we have a degree of certainty and evidence of some pragmatism, in a region which isn’t fraught with geopolitical risks.
Over the year, the portfolio has faced a series of headwinds. That said, we’ve remained focused on what we do best, casting the net wide and looking for opportunities in areas of the market under-researched by our peers. Many of the most significant opportunities have been off index plays, lesser-known companies with activities as far reaching as fertilizer production to heavy vehicle rental to electronic payments.
However, in the short-term we’ve witnessed the emergence of more pronounced country risks, and so we have spent more time examining exogenous threats. Deglobalisation and geopolitical risk are having a more profound impact, in some cases impairing corporate activity or weighing heavy on sentiment. In practice, we have started to employ country hedges successfully and will continue to do so where we see fit in 2023. We have increasingly supplemented traditional sources of research with a wider range of geopolitical views, which will continue
At the heart of our analysis is the assessment of individual companies from a fundamental and sustainability perspective. We don’t disentangle the two because we recognise that companies with strong or improving sustainability practices are best positioned to generate higher shareholder returns as well as protect portfolios from downside risks. As such companies with strong ESG credentials dominate portfolio holdings.
When we consider the influence that sustainability has on returns more broadly, it is critical to reflect on where we are now. Emerging markets are rich in natural resources, but commodity-related companies have traditionally been frowned upon by investors for whom environmental factors are a crucial consideration. As energy security has come to the fore and ESG initiatives continue to drive demand for future facing commodities, we envisage that some industries, traditionally deigned as environmental offenders will play a crucial role in executing on policy and as such may gain favour.
The value of investments can go down as well as up and investors may not get back the amount invested. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. The use of financial derivative instruments for investment purposes, may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Investors should note that the views expressed may no longer be current and may have already been acted upon. The shares in investment trusts are listed on the London Stock Exchange and their price is affected by supply and demand. Investment trusts can gain additional exposure to the market, known as gearing, potentially increasing volatility. 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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