Fidelity Emerging Markets Limited (LON:FEML) has announced the Company’s results for the year ended 30 June 2022.
Financial Highlights and Performance
Total Return in GBP for the year to 30 June 2022
|Share Price Total Return(1)
|Net asset value per Participating Preference Share Total Return(1)
|MSCI EM (TR) Index(2)
|Assets as at 30 June
|Gross Asset Exposure1
|Equity Shareholders’ Funds
|NAV per Participating Preference Share2
|Dividend per Participating Preference Share
|Gross Asset Exposure1,6
|Equity Shareholders’ Funds6
|NAV per Participating Preference Share2,6
|Participating Preference Share Price and Discount as at 30 JuneParticipating Preference Share(1)
|Participating Preference Share Price at the year end
|Discount to NAV per Participating Preference Share at year end2
|Number of Participating Preference Shares in issue
|Results for the year ended 30 June
|Revenue Earnings per Participating Preference Shares7
|Capital (Loss)/Earnings per Participating Preference Share7
|Total (Loss)/Earnings per Participating Preference Share7
|Ongoing charges ratio2,5
|(1) The value of the portfolio exposed to market price movements.
(2) Alternative Performance Measure.
(3) Gross Asset Exposure less Equity Shareholders’ Funds expressed as a percentage of Equity Shareholders’ Funds.
(4) Net Market Exposure less Equity Shareholders’ Funds expressed as a percentage of Equity Shareholders’ Funds.
(5) This ongoing charges figure is based on a reduced management fee for the year to 30 June 2022, and is anticipated to be circa 0.80% in future.
(6) The conversion from USD to GBP is based on exchange rates prevailing at the reporting dates.
(7) Calculated based on weighted average number of participating preference shares in issue during the year.
There have been multiple factors which have led to the poor performance of emerging markets, and the performance of the portfolio, during the period but the most significant of these was doubtless Russia’s invasion of Ukraine.
As described in the Portfolio Managers’ report, the Company had overweight positions in Russian companies prior to the invasion of Ukraine, which was not anticipated by the Portfolio Managers. Although this was reduced somewhat by judicious use of a hedging index short position immediately prior to the invasion, the overweight positions were not fully offset by the time the military action began.
In response to rapidly imposed sanctions by western governments, Russian authorities effectively closed their market to foreign transactions in the market and as such the manager took the decision to write the valuation of the Russian securities down to zero – leading to a significant negative impact to the valuation of the portfolio overall.
The situation in Russia also led to second order impacts, for instance a sharp re-rating of oil-rich markets such as Saudi Arabia, where the Company was underweight – leading to further relative underperformance as compared with the index. It also had a material impact on the sector positioning of the portfolio where a number of financial and energy stocks were written off creating unintended underweight positions in the short term.
Since the invasion, the Portfolio Managers have repositioned the portfolio in areas of likely growth and recovery, although this has not yet come to fruition. For example, there is now greater focus on food and energy security. The Portfolio managers have been increasing the Company’s exposure to areas such as energy, nitrogen-based fertilisers, and financials in resource rich countries.
Looking forward, the prospects for many emerging countries remain uncertain but there are reasons for cautious optimism. Their markets will be impacted by the economies and actions of developed countries as well as uncertainty due to climate change, geopolitics and potential pandemic aftershocks, but meaningful value has emerged as many stocks have already derated.
Developed markets are facing the prospect of recession, and persistent inflation. Alongside the Portfolio Managers, the Board believes that inflation will be less severe in many emerging markets but will result in higher commodity prices for several years to come. In addition, the focus on Renewables will increase demand for (and therefore the price of) ‘future facing’ commodities like copper which are vital to the build out of infrastructure and technological advancement, while the transition to renewable energy is likely to result in a structural underinvestment in fossil fuels meaning that energy prices will remain stubbornly high for some time contributing to incentivise renewables.
As ever, in periods of volatility, stock-picking opportunities arise and the Board is confident that the Portfolio Managers will use the full extent of the investment tools available to them to capitalise on the opportunities taking into account the overall world situation.
Change of Manager and Investment Manager
As set out in last year’s annual report, following the last period end several changes were made to the Company’s management arrangements. On 1 July 2021, the Board announced that it had selected FIL Investments Services (UK) Limited as the Alternative Investment Fund Manager (‘the Manager’) of the Company, with the investment management of the Company to be undertaken by FIL Investments International (the ‘Investment Manager’, ‘Fidelity International’), collectively ‘Fidelity’, to replace the previous Manager, Genesis Investment Management, LLP who remained as Investment Manager until 4 October 2021.
Change of Investment Policy
In advance of Fidelity’s formal appointment, shareholders were requested to approve a proposal to change the investment policy of the Company. The change of investment policy was duly approved by shareholders at the extraordinary general meeting (‘EGM’) held on 1 October 2021. Following shareholder approval, the Company’s portfolio was reorganised to permit the implementation of Fidelity’s investment policy.
At the heart of Fidelity’s strategy is a belief that it can deliver outsized returns in emerging markets through stock selection, driven by fundamental views. Fidelity combines skill, resource and discipline with the aim of generating enhanced risk-adjusted returns.
Change of name
As part of the change of investment management arrangements, shareholders were requested to approve a proposal to change the name of the Company to Fidelity Emerging Markets Limited. The change of name was duly approved by shareholders at the EGM held on 1 October 2021.
In response to shareholder consultation during 2018 on the level of the Company’s share price discount to NAV, the Board announced that a potential tender offer of up to 25% of the Company’s shares would be implemented in 2021, if the Company’s NAV Total Return over the five years ending 30 June 2021 did not exceed its benchmark Index. As the Company did not produce the necessary performance to outperform its benchmark Index, the Board announced that a tender offer for up to 25% of the Company’s shares in issue (excluding any shares held in treasury) (‘Tender Offer’) would be implemented subject to shareholder approval. The tender price was set at a 2% discount to the prevailing NAV per share. The Tender Offer was subsequently approved by shareholders at the EGM held on 1 October 2021.
The aforementioned Tender Offer had been put in place by the Board to enable shareholders wishing to realise part, or potentially all, of their investment in the Company the opportunity to do so.
Following completion of the Tender Offer on 22 October 2021, a total of 30,366,688 Participating Preference Shares (25% of the Company’s issued share capital) were repurchased by the Company for cancellation.
Board composition and succession planning
The Board is mindful of corporate governance best practice and recognises the need to refresh its composition from time to time. I have now served on the Board for over nine years and will duly retire from the Board following the conclusion of the 2022 annual general meeting (‘AGM’). I will be succeeded as Chairman by Heather Manners who was newly appointed as a Director of the Company on 5 May 2022. Heather is an award-winning market professional with some 34 years’ experience of investment in Asia, mostly recently, and for the past 15 years as the co-founder, CEO and CIO of Prusik Investment Management. A full biography for Heather Manners can be found on page 32.
Sujit Banerji will have served as a Director of the Company for nine years in October 2022 and will also retire following the conclusion of the 2022 AGM.
Russell Edey has also indicated his intention to retire as a Director of the Company in 2023. Having engaged the services of executive head-hunter, our search for his successor, as Chairman of the Audit Committee, is already underway and it is anticipated that a new director will be appointed before the end of 2022 to ensure a smooth handover.
All Directors other than Sujit Banerji and myself are offering themselves for re-election at the forthcoming AGM.
A resolution to declare a final dividend of 16 cents per share will be proposed at the AGM of the shareholders of the Company that will be held on Thursday, 8 December 2022. Subject to shareholder approval, the final dividend will be paid on 16 December 2022 to shareholders on the Register of Members on 18 November 2022. The ex-dividend date is 17 November 2022.
Annual General Meeting
This year’s AGM will be held on Thursday, 8 December 2022 at 11:00 a.m. at the registered office of the Company, 1st Floor, Les Echelons Court, Les Echelons, South Esplanade, St Peter Port, Guernsey GY1 6JB.
Notice of the AGM, containing full details of the business to be conducted at the meeting, is set out in the Annual Report.
Your attention is also drawn to the Directors’ Report within the Annual Report, where resolutions relating to special business are explained.
Electronic proxy voting is now available and shareholders are encouraged to submit voting instructions using the web-based voting facility at www.eproxyappointment.com and www.proxymity.io for institutional shareholders. In order to use electronic proxy voting, shareholders will require their shareholder registration number, control number and pin. If you do not have access to these details please contact the Company’s Registrar, Computershare, their contact details can be found in the Annual Report.
6 October 2022
Portfolio Managers’ Review
|Question Performance in the year to 30 June 2022 has been disappointing – what were the major causes?
Nick:As set out below, the major reason for underperformance since Fidelity took on management of the Company was Russia’s invasion of Ukraine. Sadly, we underestimated both the likelihood, and the impacts of the invasion.
|Question Reflecting on the war in Ukraine, how was the Company positioned before the invasion and what impact did it have on the portfolio?
Nick:I’ve invested in Russian stocks since 2005; it’s a market with a chequered history, which has largely been reflected in the price. When the war broke out, the portfolio was exposed to a series of Russian businesses, which were cheap, offered the best dividends in the world, and operated in cyclical sectors such as mining or domestic industries such as banking which thrive when oil and gas prices are high. With inflation ratcheting up in 2021, these stocks played an important role in providing portfolio balance and had performed well against this backdrop. As troops amassed, we had reduced the residual country bet using an index hedge, however, fundamentally the companies themselves were generating strong cash flows and the dividends payable to shareholders were more than sufficient to compensate for share price weakness. We debated the risks extensively in-house and with external experts, however, we did not conclude there was a risk of a full-scale invasion and all-out war in Ukraine. At the time, we felt the risks were similar to those in 2014 when Russia annexed Crimea and Russian markets remained functioning. As events unfolded rapidly and sanctions were imposed the Russian authorities retaliated by preventing foreigners from transacting in the market. We had taken some immediate steps to reduce exposure, but the right to transact in the market for overseas investors was withdrawn quickly. The inability to trade meant that there was no price discovery, and as such Fidelity’s Fair Value Team stepped in to review the holdings as ‘Hard to Price Assets’. Given the complete lack of liquidity in these stocks, the holdings were written down to zero which was reflected in the NAV at the time. The impact on performance was significant, albeit the hedge served to offset some of these losses. The effects were however more widespread than Russia, as a series of second-order impacts, such as a sharp and indiscriminate rally in specific markets. For instance, the rally in Saudi Arabia (a perceived beneficiary of Russia’s newfound pariah status) was detrimental because the portfolio had owned Russia in preference to the likes of Saudi. Consequently, performance issues were further compounded by an underweight to the Middle East.
|Question What have the other implications been for the portfolio and emerging markets because of Russia’s invasion of Ukraine?
Nick:Given Russia’s effective exclusion from the investable universe, we have recalibrated other parts of the portfolio. We sought new opportunities in areas such as Brazil and the Middle East, spending time on the ground meeting companies. The removal of Russia makes the focus on its commodity exporting ‘competitors’ more important. By design, newly added positions typically exhibit value, given persistent inflation and higher rates. Moreover, opportunities to invest in businesses with direct and indirect exposure to higher commodity prices has been a common trait, particularly where this is coupled with a compelling dividend yield. The additional inflationary shock that arose from the conflict has meant that cash flows have been rising as buyers have sought alternative sources for key commodities. Whilst prices may be volatile, given fears of a global recession, one of the impacts of the war is significant supply disruption, in what were already tight markets and a greater focus on food and energy security which will, in our view lend a level of support to prices over the medium to long-term. With all these factors in mind, energy, nitrogen-based fertilisers, and financials in resource rich countries have been an area of focus.
|Question Other than Russia, how did you set about transitioning the portfolio to Fidelity at the start of 2021?
Nick:Following our appointment in October 2021, we took steps to ensure the Company’s portfolio was well-balanced and reflected those areas where we had the highest conviction. We built up exposure to leading, innovative tech companies which play a crucial role in providing the building blocks for processing power and storage in a world where there is persistent and structural demand for data. Similarly, we added positions in copper where there are long-term structural drivers. Tightening emissions regulations and government incentives are lifting demand for cleaner fuels and electric vehicles. Whilst these decisions are driven by a bottom-up, stock picking approach, increasing holdings in areas such as mining reflected our view that inflationary pressures were rising and as such these holdings could act as a natural hedge as commodity prices rose. We also exploited the closed ended nature of the investment company and moved down the market cap spectrum to take full advantage of our research platform, adding smaller, under-researched stocks. We took a cautious stance on areas exposed to continued regulatory risks such as the Chinese internet stocks and businesses with activities exposed to the capital cycle, although as the months passed these have become areas of interest, as beaten-up industries provided good entry points to acquire attractive businesses at multi-year low.
|Top 5 Positions
|As at 30 June 2022
|Taiwan Semiconductor Manufacturing
|Alibaba Group Holding
|China Mengniu Dairy
|Question The portfolio can use derivatives under its new policy. What can you say about how they helped the portfolio this past year?
Chris:The closed ended structure and newly introduced investment policy allow us to employ a much broader set of strategies than a traditional long-only fund, to express both positive and negative investment views in an efficient manner. Having more tools at our disposal is particularly valuable in emerging markets which are more volatile, and valuations can move to extreme levels in both directions. Long positions are focused on businesses which are dominant in their markets and short positions are targeted at the weakest stocks most exposed to competitive threats and financial distress. These weaker businesses can provide an additional source of performance. Whilst stock picking is our core strength, we recognise that country risk can be elevated in emerging markets. As previously highlighted a country-specific hedge allowed us to build in some portfolio protection in Russia given growing geopolitical tensions in Ukraine. In early December 2021, we added an index short to reduce that country risk. When the war broke out the hedge served to mitigate some of the losses experienced at the stock level.
|Question How will you position the portfolio going forward considering heightened geopolitical risk?
Nick:Geopolitical tensions give rise to many discussions about how we, as stock pickers account for those risks. In a normal environment valuation will reflect concerns, but we are conscious that country risks became greatly amplified during the last 12 months, and so the use of country hedges can play a key role. We are not obliged to be invested in each market, and if we believe the risk is too high, we can of course avoid impacted industries/markets. Our positioning in China has reflected this in practice; when the US ratcheted up pressure on China through various tariffs and sanctions, we avoided those areas of the market. More broadly, country bets are being maintained at more muted levels currently than historically. They are a residual of our stock picking approach, but we have been deliberate in maintaining more prudent active weights in recent times.
|Question You’ve mentioned China on a couple of occasions, how do you feel about the market at this stage and looking ahead?
Nick:We are now seeing opportunities in China following a litany of negative news over the past 18-24 months that has dragged the market down: the debt-crisis at property developer Evergrande, tighter regulations which wiped out sectors such as education, the halting of Ant Group’s Initial Public Offering (IPO) and the ongoing concerns about the ability of American Depositary Receipts (ADRs) to remain listed in the US. More recently, China’s zero-tolerance Covid policy has resulted in the lockdown of millions of people. Valuations have fallen a long way and are in many cases at the cheapest levels we have seen in a decade, making certain areas of the market incredibly attractive. Amongst property developers there are many with weak statement(s) of financial position, but that provides the strongest players with a good competitive backdrop. There will be less competition for buying land from local governments, boosting the prospects of companies like China Overseas Land, which boasts a solid statement of financial position, strong dividend, and trades below book value. I also expect the Chinese government to relax some of its regulations in property over the coming months which could spark a revival in some of the demand drivers in property in 2023. The other area where I see value is the internet space, where we witnessed huge falls in stock prices. Alibaba the poster child of China’s tech industry has fallen by more than 50% from its 2020 highs. But when you consider its cloud business and Ant Financial, there is still a lot of value in this stock. Moreover, the company is currently buying back billions of dollars of shares as well as cutting costs. So, we could have a reversal of share price decline that we have seen over the past two years or so.
|Question Chris, how about shorts? Are there any areas of the market you can pinpoint which speak to some of the big picture topics which have dominated headlines this year?
Chris:Clearly the consumer is under immense pressure, as the cost of living rises this shines a light on more vulnerable retailers. We have added new positions to companies with stretched statement(s) of financial position where the cost of servicing that debt burden is rising, and demand looks more precarious. Elsewhere, silver has suffered in the wake of higher interest rates and concerns about demand for industrial metals. Silver is widely regarded as a precious and an industrial metal meaning that it is exposed to the impact of higher interest rates, as an inflation hedge, but also as an industrial metal, making it vulnerable to fears that demand will be weak. Given this, on a highly selective basis we have added shorts where operational challenges are evident, and leverage is high.
|Question Nick, having invested through many unique and challenging market conditions in your career. What makes this year different in your view?
Nick:Two aspects stand out to me. Firstly, at the highest level, we have seen a secular shift which has come about following years of declining rates and stimulus which have benefitted equity markets and growth assets. With the era of ‘easy money’ over, valuation discipline is more critical and stocks with little to no current earnings naturally lose favour. Whilst there are challenges ahead and a high degree of uncertainty, such an environment does lend itself to a more prudent, highly selective approach. Secondly our inability to trade the Russian market for such an extended period is not something we would ever have anticipated. Whilst I have witnessed extreme market dislocation, the lack of price discovery is unprecedented.
|Question How does Fidelity differentiate itself as an emerging markets asset manager?
Chris:Differentiation is key. The enormity of the research engine at Fidelity sets us apart from our peers. The evolution of my role demonstrates this which has worked collaboratively in sector- specific, regional and global teams as part of an integrated research platform. In the early stages of my investment career, I was a mining analyst, distinctly covering companies operating in the EMEA and Latin America regions. To fulfil that role, I had to have intimate knowledge of a series of businesses operating in the sector. I spent time on the ground at production facilities so I could see for myself the extent of the companies’ operations. To complement this, I was part of Fidelity’s broader natural resources team, with peers assigned to stocks as far afield as Canada and Australia. The nature of the sector meant that collaborative efforts were central to our work, as we examined supply and demand dynamics globally. In parallel we needed to understand the ‘customers’, such as the Chinese real estate developers, so here again your Fidelity network of research peers covering related industries in different markets is critical to building a holistic view. In practice, the insights from the research team can play out through long positions and short positions, so as my career evolved, I moved to a role specialising in identifying shorting opportunities in emerging markets. In this context I was able to draw on the platform again. Another key benefit of the platform is its large geographical footprint, which means that I can have my feet on the ground in Brazil, whilst my colleagues in India or Shanghai are spending face time with companies operating in those markets. With such a vast investible universe and in a world where mobility is still restricted in certain corners, this is of vital importance.
|Question How do you think the fundamentals of Emerging Market economies of the last 10 years will compare to the next 10 years?
Chris:Historically the most important driver was the Chinese real estate sector, which had far-reaching ramifications for emerging markets broadly and areas such as European industrials. Looking ahead energy transition will play a pivotal role, in a myriad of ways. The move to renewables is likely to result in a structural underinvestment in fossil fuels meaning that energy prices remain stubbornly high for some time which will help incentivise renewables. Renewables are very capital intensive, which is good for certain ‘future facing’ commodities like copper which are vital to the build out of infrastructure and technological advancement. This latter is critical given that to date the ability to store energy between seasons has historically proven difficult. Deglobalisation can take hold over the next decade, fuelled by concerns about security which at first centred on technology but more recently have anchored on fears about food and energy security. Looking ahead onshoring and near shoring can bring benefits to a wider range of developing countries such as Thailand, Vietnam, Mexico, and parts of Eastern Europe.
|Question What are the implications of global inflation, debt in emerging economies and the risk of stagflation in the western world?
Nick: This is a massive topic, and one that all investors are having to factor into their thinking. The western world is already in a phase of very low growth, with recession coming late in 2022 or early 2023. Inflation, in the medium term, is likely to persist for many reasons. The focus that has been put on climate change (the risks of which are undeniable) by many investment portfolios has driven low levels of capital expenditure in Oil & Gas when energy prices are spiking. Climate change itself is impacting soft commodities (such as crops and livestock) and high levels of unsustainable sovereign debt in the west require quantitative easing. This adds to structural shifts such as a fall in cheap exports from China and changing demographics in the western world reducing the labour pool. Debt in emerging economies has also grown. It may still be lower than the western world, but nevertheless requires scrutiny. The good news is that many emerging countries have been disciplined in raising rates, and developing countries may attract investment based on their relative strength.
|Question How do you view the current risks and rewards in frontier markets and smaller companies?
Nick: Although there are always stock specific opportunities, the issue with frontier markets in general is that the economies are extremely fragile, with populations frequently living on the breadline. The stresses of a strong US Dollar and higher energy costs create a difficult mix. It is well-documented that countries such as Ghana, Nigeria, Egypt, Sri Lanka, Bangladesh are all experiencing economic stresses both at a sovereign level and amongst the population. Pakistan was already in this mix and has seen unprecedented flooding widely linked to climate change (a risk which will only increase with time). I am also conscious that liquidity in these markets is very tight. My experience is – a lot like The Eagle’s song “Hotel California” – you can check in but can never check out. Smaller companies, conversely, can be very attractive. They are often overlooked, and you can find great companies with good management teams and cheap valuations. The Company looks to take advantage of these opportunities.
Nick Price/Chris Tennant
6 October 2022
Investment Strategy and Policies
Business and Status
The Company is a closed-ended investment scheme authorised by the Guernsey Financial Services Commission and is listed on the London Stock Exchange.
The Company was incorporated in Guernsey on 7 June 1989 and commenced business on 19 September 1989.
Reviews of the Company’s activities are included in the Chairman’s Statement and Portfolio Managers’ Investment Review.
During the year to 30 June 2022, as set out below, the Company changed its management arrangements, although the Company remains focused on investing in emerging markets. The Directors anticipate that the Company will continue to operate in the same manner during the current financial year following the appointment of Fidelity.
Change of Manager and Investment Manager
The Board has invested considerable time and effort in considering the future direction for the Company in order to best serve the interests of the Company’s shareholders as a whole.
With this in mind, the Board conducted an extensive review of the Company’s management arrangements and reached the conclusion that Genesis Investment Management LLP should be replaced by FIL Investment Services (UK) Limited as the Company’s Manager. This process included consultation with major shareholders.
FIL Investment Services (UK) Limited (‘the Manager’) was formally appointed on 4 October 2021.
The Manager has delegated the role of Investment Manager to FIL Investments International (‘Fidelity International’, the ‘Investment Manager’). Both the Manager and Investment Manager are part of the FIL Group of companies, collectively ‘Fidelity’.
Investment Objective and Policy (for the period from 1 July 2021 to 3 October 2021)
The Company’s investment objective is to achieve long- term capital growth from an actively managed portfolio made up primarily of securities and financial instruments providing exposure to emerging market companies, both listed and unlisted.
The Company seeks to identify high-quality companies in emerging markets and invest in them at attractive discounts to their intrinsic value
Following shareholder approval at the EGM of the Company held on 1 October 2021 the Company’s investment objective and policy is now as follows:
Investment Objective (for the period 4 October 2021 onwards)
The Company’s investment objective is to achieve long-term capital growth from an actively managed portfolio made up primarily of securities and financial instruments providing exposure to emerging market companies, both listed and unlisted.
The Company seeks to meet its investment objective through investment in a diversified portfolio of equity or equity-linked securities and derivative instruments providing exposure to emerging market companies.
The Manager integrates sustainability analysis into its investment process and promotes environmental and social characteristics in respect of the companies in which it invests.
Investment minimum constraints
At least 80% of the Company’s total assets (measured at the time of investment) will be exposed to companies that have their head office in, are listed in or with assets, operations, income or revenues that are predominantly in or derived from emerging markets.
The Company is not subject to any geographical or sector limits, although the Manager will maintain a diversified portfolio of a minimum of 75 holdings (comprised of a mixture of long and short exposures) in companies listed in or operating across at least 15 countries.
Fidelity is not required to seek to ensure that the Company’s cash resources are fully invested at all times. Accordingly, there may be times when the Company holds cash or money market instruments pending investment. The Company’s net market exposure will not fall below 90% of the Company’s net assets save to the extent that the Manager is required to realise cash to fund a tender offer or other return of capital.
The Company may invest through equities, index linked securities, contracts for difference (CFD), equity linked and other debt securities, cash deposits, money market instruments, equity related securities, foreign currency exchange forward transactions and other interests including derivative instruments. The Company may invest directly in China A and B Shares and invest in Non- Voting Depository Receipts, American Depositary Receipts, Global Depositary Receipts and Equity Linked Notes. References to “companies” in this investment policy may include operating businesses that are not in corporate form.
Forward transactions and derivatives, including futures, options, swaps and contracts for difference, may be used to enhance portfolio performance as well as for efficient portfolio management and hedging.
The Company may invest in unlisted securities and in other investment funds, subject to the investment restrictions set out below.
The Company will invest and manage its assets with an objective of spreading risk with the following investment restrictions:
|– no single or aggregate interest in any one company shall represent more than 15% of total assets (measured at the time of investment);
|– no more than 15% of total assets (measured at the time of investment) may be invested in unlisted securities;
|– up to 15% of total assets (measured at the time of investment) may be invested in other listed or unlisted investment funds where such funds offer the only practicable means of gaining exposure to a particular emerging market, including other funds managed or advised by the Manager or its associates;
|– up to 20% of total assets (measured at the time of investment) may be invested in securities and instruments which provide exposure to companies which do not have their head office in, are not listed in or whose assets or operations are not predominantly in emerging markets, provided that a material proportion of the income or revenues of each such company derives from emerging markets.
Although the Company has no present intention to make any such investments, for so long as required by the Listing Rules, no more than 10% of the Company’s total assets (measured at the time of investment) may be invested in other London-listed closed ended funds that do not have stated policies to invest no more than 15% of their total assets in other London-listed closed ended funds.
Leverage and derivatives
The Company may be geared through (i) borrowing of up to 10% of its net asset value and/or (ii) by entering into derivative positions (both long and short) which have the effect of gearing the Company’s portfolio, to enhance performance.
Derivatives usage will focus on, but will not be limited to the following investment strategies:
|– as an alternative form of gearing to bank loans, for instance by the use of long CFDs;
|– to enhance the investment returns by taking short positions in stocks or markets that the Manager considers to be over-valued or impaired;
|– to enhance positions, manage position sizes and control risk through the use of options;
|– to hedge equity market risks where suitable protection can be purchased to limit the downside of a falling market at a reasonable cost; and
|– to gain or hedge currency exposure, both long and short, using foreign currency exchange forward transactions.
The Company is subject to the following limits in respect of its use of derivatives:
|– Net Market Exposure will not exceed 120% of the net asset value of the Company.
|– Gross Asset Exposure will not exceed 165% of the net asset value of the Company.
|– In normal market circumstances, the Company expects that the Manager will maintain a Net Market Exposure in the range of 100% to 110%.
|– Long Exposure is the value of the Company’s direct and indirect investments in long positions (including the economic value of the exposure to the reference asset of any derivative instrument).- Short Exposure is the value of the Company’s direct and indirect investments in short positions (including the economic value of the exposure to the reference asset of any derivative instrument), excluding Hedges.
|– Hedges are short positions that demonstrate risk-reduction qualities by offsetting long positions held by the Company which have regional congruence and a correlation of at least 80% to the Long Exposure of the Company.
|– Net Market Exposure is the net positive market exposure of the Company’s portfolio, whether through direct or indirect investment, with short and hedge positions subtracted from long positions. It is calculated as (Long Exposure – Hedges) – Short Exposure.
|– Gross Asset Exposure is the total market exposure of the Company’s portfolio, whether through direct or indirect investment. It is calculated as: (Long Exposure + Short Exposure) – Hedges.
The Company’s benchmark is the MSCI Emerging Markets (Total Return) Index.
Life of the Company
The Company has committed to hold a continuation vote in 2026 and every five years thereafter. The Company will propose the continuation vote at its annual general meeting in the relevant year and, if the continuation vote is not passed, will thereafter present proposals to shareholders in respect of the future of the Company.
The Company has no employees or premises and the Board is comprised of non-executive Directors. During the year under review, the majority of day-to-day operations and functions of the Company were delegated to GIML and to third party service providers who are subject to the oversight of the Board. There are therefore no disclosures to be made in respect of employees.
During the year under review GIML provided investment and risk management services, JP Morgan Chase Bank was the Custodian and JP Morgan Administration Services (Guernsey) Limited was the Administrator and Company Secretary. The Board regularly reviews the performance and risks of its primary service providers and checks that they have appropriate frameworks in place for the oversight of their internal controls, monitoring and reporting.
With effect from 4 October 2021, the day-to-day operations and functions of the Company previously delegated to GIML will be undertaken by Fidelity.
Principal and Emerging Risks and Uncertainties, Risk Management
In accordance with the AIC Code, the Board has a robust ongoing process for identifying, evaluating and managing the principal risks and uncertainties faced by the Company, including those that could threaten its business model, future performance, solvency or liquidity. The Board, with the assistance of the Alternative Investment Fund Manager (FIL Investment Services (UK) Limited/the “Manager”), has developed a risk matrix which, as part of the risk management and internal controls process, identifies the key existing and emerging risks and uncertainties that the Company faces. The Audit and Risk Committee continues to identify any new emerging risks and take any action necessary to mitigate their potential impact. The risks identified are placed on the Company’s risk matrix and graded appropriately. This process, together with the policies and procedures for the mitigation of existing and emerging risks, is updated and reviewed regularly in the form of comprehensive reports considered by the Audit and Risk Committee. The Board determines the nature and extent of any risks it is willing to take in order to achieve its strategic objectives.
The also has responsibility for risk management for the Company. It works with the Board to identify and manage the principal and emerging risks and uncertainties and to ensure that the Board can continue to meet its Corporate Governance obligations.
Key emerging issues that the Board has identified include; rising geopolitical tensions, including contagion of the Ukraine crisis or tensions between China and Taiwan into the wider region or an increase in tensions in the South China Sea; rising inflation and the so-called cost of living crisis impacting demand for UK-listed shares; and climate change, which is one of the most critical emerging issues confronting asset managers and their investors. The Board notes that the Manager monitors these issues, and has integrated macro and ESG considerations, including climate change, into the Company’s investment process. The Board will continue to monitor how this may impact the Company as a risk, the main risk being the impact on investment valuations.
The Board considers the following as the principal risks and uncertainties faced by the Company.
|Risk Description and Impact
|Volatility of Emerging Markets and Market Risks
|– The economies, currencies and financial markets of a number of developing countries in which the Company invests may be extremely volatile. – Further risks on emerging markets from rising inflation, a resurgent pandemic and tightening financial conditions exacerbated by the war in Ukraine. – Market volatility from worsening Chinese/ Taiwanese relations that could prompt the US to intervene. – US imposed Executive Orders prohibiting US investments in certain Chinese companies and the passing of the Holding Foreign Companies Accountable Act (HFCAA). – Rising geopolitical tensions, including contagion of the Ukraine crisis or tensions between China and Taiwan into the wider region. – The Chinese economy and global supply chains, remain vulnerable to China’s zero COVID policy and the continued use of localised lock downs. – Regulatory measures impacting the IT sector and a lingering weakness in the real estate sector.
|– The Company’s investments are geographically diversified in order to manage risks from adverse price fluctuations. – Russian securities already held at nil value. – The exposure to any one company is unlikely to exceed 5% of the Company’s net assets at the time the investment is made. – Review of material economic or market changes and major market contingency plans for extreme events. – China’s increasing integration into the global financial system and into global supply chains. – Companies that were solely listed in the US are listing on the HK or mainland markets.
|Investment Performance Risk
|– The Portfolio Manager fails to outperform the Benchmark Index over the longer-term.
|– An investment strategy overseen by the Board to optimise returns. – A well-resourced team of experienced analysts covering the market. – Board scrutiny of the Manager and the ability in extreme circumstances to change the Manager.
|Cybercrime and Information Security Risks
|– Cybersecurity risk from COVID-19 or successor pandemics affecting the functioning of businesses and global markets. – Cybersecurity risk from COVID-19 or successor pandemics affecting the functioning of businesses and global markets. External cybercrime threats such as spam attacks and DDoS (Distributed Denialof Service) attacks and reputational risk arising from accidental data leakage.
|– The risk is monitored by the Board with the help of the extensive Fidelity global cybersecurity team and assurances from outsourced suppliers. – Development of systems and procedures by the AIFM resulting from the experience of the COVID-19 pandemic and cyber activity following the Russian invasion of Ukraine.
|Business Continuity & Event Management Risks
|– The COVID-19 pandemic continues to pose risks to the Company (albeit reducing in part), such as liquidity risks to markets, risks associated with the maintenance of the current dividend policy and business continuity risks for the Company’s key service providers. – The Russian/Ukraine conflict has increased the risk for working from home or in offices, specifically concerning the potential loss of network outages.
|– Event and Crisis Management teams meet regularly to ensure readiness for a multitude of scenarios, including communication, power failure and the potential escalation of conflicts and actions taken by other nations including Russia, China and other emerging markets. – Digital teams continue to maintain solutions to allow business continuity and operational
|– The Portfolio Manager fails to use gearing effectively, in a failure to outperform ina rising market or to underperform in a falling market.
|– The Board sets a limit on gearing and provides oversight of the Manager’s use of gearing.
|Discount to Net Asset Value (NAV) Risk
|– The share price performance lags NAV performance. – The Board fails to implement its discount management policy. – Rising energy costs and cost of living crisis impact on retail demand for shares.
|– The Board reviews the discount on a regular basis and has the authority to repurchase shares so shares can trade at a level close to the NAV. – If the NAV for the five years ending 30 September 2026 does not exceed the Benchmark Index, the Company will make a tender offer of up to 25% of the shares in issue at that time.
|Unlisted Securities Risk
|– Market conditions may not permit unlisted companies to come to IPO and achieve marketability. – Potential for less stringent standards of governance compared with those of listed entities. – Higher degree of valuation and performance uncertainties and liquidity risks.
|– The Company has a limit on the extent of the investment in unlisted companies and has not yet purchased any new pre-IPO stocks under its new investment policy. – Scrutiny by the Board’s Audit and Risk Committee of the carrying value of unlisted securities.
|Foreign Currency Exposure Risk
|– The functional currency in which the Company reports its results is US dollars, whilst the underlying investments are in different currencies. The value of assets is subject to fluctuations in currency rates and exchange control regulations.
|– The Portfolio Manager does not hedge the underlying currencies of the holdings in the portfolio but will take currency risk into consideration when making investment decisions.
|Lack of Market Liquidity Risk
|– Low trading volumes on stock exchanges of less developed markets. – Lack of liquidity from temporary capital controls in certain markets. – Exaggerated fluctuations in the value of investments from low levels of liquidity.
|– Restrictions on concentration and diversification of the assets in the Company’s portfolio to protect the overall value of the investments and lower risks of lack of liquidity.
|Environmental, Social and Governance (ESG) Risk
|– The adoption of international standards may adversely impact the profitability of companies in the portfolio. – The Manager fails to meet its regulatory requirements on ESG, including climate risk, in relation to the Company. – Higher degree of valuation and performance uncertainties and liquidity risks.
|– Fidelity has adopted a sophisticated and comprehensive system for analysing ESG risks, including climate risk, in investee companies. – The Portfolio Manager is active in analysing the effects of ESG when making investment decisions.
|Key Person Risk
|– Loss of the Portfolio Manager or other key individuals could lead to potential performance and/or operational issues.
|– Succession planning for key dependencies. – Depth of the team within Fidelity. – Experience of the analysts covering the Company’s investments.
Other risks facing the Company include:
Tax and Regulatory Risks
There is a risk of the Company not complying with the regulatory requirements of the Guernsey Financial Services Commission, UK listing rules, corporate governance requirements or local tax requirements that could result in loss of status as an Authorised Closed Ended Investment Scheme, becoming subject to additional tax charges or to exclusion from trading in particular markets.
The Board monitors tax and regulatory changes at each Board meeting and through active engagement with regulators and trade bodies by the Manager.
The Company relies on a number of third-party service providers, principally the Manager, Registrar, Custodian and Depositary. It is dependent on the effective operation of the Manager’s control systems and those of its service providers with regard to the security of the Company’s assets, dealing procedures, accounting records and the maintenance of regulatory and legal requirements. The Registrar, Custodian and Depositary are all subject to a risk-based programme of internal audits by the Manager. In addition, service providers’ own internal control reports are received by the Board on an annual basis and any concerns are investigated. Risks associated with these service providers is rated as low, but the financial consequences could be serious, including reputational damage to the Company.
In accordance with provision 35 of the 2019 AIC Code of Corporate Governance the Directors have assessed the prospects of the Company over a longer period than the twelve month period required by the “Going Concern” basis. The Company is an investment fund with the objective of achieving long-term capital growth investing in emerging markets. The Board considers long-term to be at least five years, and accordingly, the Directors believe that five years is an appropriate investment horizon to assess the viability of the Company, although the life of the Company is not intended to be limited to this or any other period. In making an assessment on the viability of the Company, the Board has considered the following:
|– The ongoing relevance of the investment objective in prevailing market conditions;
|– The Company’s NAV and share price performance;
|– The principal and emerging risks and uncertainties facing the Company as set out above and their potential impact;
|– The future demand for the Company’s shares;
|– The Company’s share price discount to the NAV;
|– The liquidity of the Company’s portfolio;
|– Consideration of the continuation vote in 2026;
|– The level of income generated by the Company; and
|– Future income and expenditure forecasts.
The Company has assumed for the purposes of the viability statement that the continuation vote in 2026 would be passed.
The Company’s performance for the five year reporting period to 30 June 2022 is notably behind the Benchmark Index, with a NAV total return of -27.9%, a share price total return of -30.0% compared to the Benchmark Index total return of -14.9%, but the Board notes the significant impacts of the war in Ukraine, which it believes to be idiosyncratic and unlikely to be repeated in the near term.
The Board regularly reviews the investment policy and considers whether it remains appropriate. The Board has concluded that there is a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the next five years based on the following considerations:
|– The Investment Manager’s compliance with the Company’s investment objective and policy, its investment strategy and asset allocation;
|– The fact that the portfolio comprises sufficient readily realisable securities which can be sold to meet funding requirements if necessary;
|– The Board’s discount management policy; and
|– The ongoing processes for monitoring operating costs and income which are considered to be reasonable in comparison to the Company’s total assets.
When considering the risk of under-performance, a series of stress tests was carried out including in particular the effects of any substantial future falls in investment value on the ability to maintain dividend payments and repay obligations as and when they arise.
In preparing the Financial Statements, the Directors have considered the impact of climate change, particularly in the context of the climate change risk identified within the ESG Risk in the Annual Report. The Board has also considered the impact of regulatory changes and how this may affect the Company. In addition, the Directors’ assessment of the Company’s ability to operate in the foreseeable future is included in the Going Concern Statement which is included in the Directors’ Report within the Annual Report.
Duty to promote the success of the Company
A director of a company must act in a way he/she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other things) to:
|– the likely consequences of their decisions in the long term;
|– the interests of the company’s employees;
|– the need to foster the company’s business; relationships with suppliers, customers and others;
|– the impact of the company’s operations on the community and the environment;
|– the desirability of the company maintaining a reputation for high standards of business conduct; and
|– the need to act fairly as between members of the company.
As an externally managed investment company, the Company has no employees or physical assets. The key stakeholders in the Company are its shareholders, the Manager, the Investment Manager, and other third party service providers.
The Board seeks to ensure high standards of business conduct are adhered to by all of the Company’s service providers and that agreed service levels are met.
The Board is responsible for promoting the long-term success of the Company for the benefit of all stakeholders and in particular its shareholders. Although the majority of the day-to-day activities of the Company are delegated to the Manager, Investment Manager, and other third party service providers, the responsibilities of the Board are set out in the schedule of matters reserved for the Board and the relevant terms of reference of its committees, all of which are reviewed regularly by the Board.
To ensure that the Board is able to discharge this duty, the Manager, Investment Manager and other third party service providers are required to provide the Board with regular updates. In addition, Directors, or the Board as a whole, have the authority to seek advice from professional advisers including the Company Secretary and independent external advisers as well as attend any relevant training seminars.
The investment management function is critical to the long- term success of the Company. During the period under review, the Board monitored the performance of GIML and Fidelity against key performance indicators. The Board received updates from GIML and Fidelity on the performance of the Company at each Board meeting with additional performance updates being provided on a monthly basis. In addition to performance updates, the Board received regular updates on the marketing of the Company from both GIML and Fidelity and the Company’s brokers. As part of these updates the Board received and considered feedback from its shareholders.
During the period under review, GIML and Fidelity and the Company’s corporate brokers held periodic meetings with the Company’s major shareholders to discuss aspects of the
Company’s positioning, performance and outlook. Members of the Board were available to attend meetings with shareholders upon request.
The Board also received updates from its key third party service providers at each Board meeting, the main purpose of which is to ensure that the services provided to the Company remain in line with expectations and are to the benefit of its shareholders.
The Board also considered the impact of the Company’s decisions on the environment and the community. The Board received updates on ESG matters from GIML and Fidelity and discussed how ESG factors are taken into account by GIML and Fidelity as part of its selection process of investee companies.
The Board recognises the need for good communications with its shareholders and is committed to listening to their views. The primary medium through which the Company communicates with shareholders is through its Annual and Half Year Financial Reports. Monthly factsheets are also produced. Company related announcements are released via the Regulatory News Service (‘RNS’) to the London Stock Exchange. All of the aforementioned information is available on the Company’s website www.fidelity.co.uk/emergingmarkets.
In addition to the annual general meeting, all shareholders are invited to attend the Company’s annual information meeting. This provides shareholders with the opportunity to interact directly with the Board.
The Board can be reached via either the Investment Manager or the Company Secretary at the addresses within the Annual Report.
Examples of the principal decisions taken by the Board during the year under review (and post year-end) are as follows:
Change of Manager and Investment Manager – following the underperformance of the Company against its benchmark over five years, the Board decided to undertake a thorough review of its investment management arrangements. In June 2021, the Company’s brokers were instructed to invite tenders to provide investment management services to the Company. Following a competitive tender process, the Board announced that it had selected FIL Investments Services (UK) Limited as Manager of the Company, with the investment management of the Company to be undertaken by FIL Investments International, collectively ‘Fidelity’. Fidelity has a depth of expertise in emerging markets, and a proven track record of managing and growing investment trusts. The Board believes that the Company will benefit considerably from Fidelity’s brand, and its ability to attract a larger range of shareholders with its significant and broad ranging marketing resource. In addition, the appointment of Fidelity brings a significant saving in ongoing management fees from 0.90 per cent to 0.60 per cent. of net asset value.
The activities and processes performed by Fidelity following its appointment on 4 October 2022 are expected to be broadly consistent those provided by GIML with the addition of activities relating to derivatives trading.
Covid-19 – The Board continues to review emerging risks that could have a potential impact on the operational capability of the Investment Manager and the Company’s other key service providers. During the year under review, the Board received updates from GIML (up until their resignation) and Fidelity and other key service providers confirming that they continued to service the Company in line with service level agreements and have suitable arrangements in place to ensure that they can continue to provide their services to the Company during the ongoing pandemic.
Succession Planning – as previously detailed in the Chairman’s Statement, and in the Nomination Committee’s Report within the Annual Report, both Helene Ploix and Sujit Banerji will retire as Directors of the Company following the conclusion of the 2022 AGM. Russell Edey has also indicated his intention to retire from the Board in 2023. Having engaged the services of executive head-hunter, our search for his successor, as Chairman of the Audit Committee, is already underway and it is anticipated that a new director will be appointed before the end of 2022 to ensure a smooth handover.
Marketing – marketing has continued in support of widening the Company’s shareholder base. The Board agreed that the ongoing marketing of the Company was a key consideration of the tender process, and it is hoped that the Company will benefit considerably from Fidelity’s brand, and its marketing resources.
The Board is committed to the long term success of the Company for the benefit of its shareholders, however in doing so it also has regard to the impact of its actions on all of its stakeholders. The Board takes into account section 172 considerations in all material decisions of the Company.
The Company’s policy on board diversity is included in the Nomination Committee’s Report as contained in the Annual Report.
Environmental, Social and Governance Factors
During the year under review, the Fidelity investment team assessed ESG factors, including climate-related risks and opportunities, in the context of materiality, mindful of the Sustainability Accounting Standards Board framework. Sector Specialists are responsible for assessing the materiality and relevance of ESG factors in their respective sectors and providing an ESG framework to the team. Each Portfolio Manager (‘PM’) is individually responsible for the integration of the relevant ESG factors into their investment analysis of a company, before investing in a company and throughout the investment period.
Fidelity’s Annual Stewardship Report 2021 (formally the Annual ESG Report) can be found on their website, www.fidelity.co.uk/responsible-investing. The Stewardship report contains more information on ESG integration in the portfolio as well as Fidelity’s approach to stewardship and a qualitative review of the top ten portfolio positions including the company-level ESG metrics.
Similarly, Fidelity is committed to ESG and incorporates ESG factors into its investment process. Details can be found at www.fidelity.co.uk/responsible-investing.
Signed on behalf of the Fidelity Emerging Markets Board
6 October 2022