Fidelity: Franchise update - Emerging Markets

Key points

• The two big factors currently driving emerging markets equities are falling inflation and weaker than expected Chinese consumer demand.
• Recent portfolio performance has been buoyed by strong returns from technology stocks, while our holdings in selected Chinese consumer stocks have detracted. 
• We believe emerging markets still presents compelling opportunities from a fundamental and valuation perspective. Our focus remains on owning well capitalised businesses with strong balance sheets.

Market backdrop

There are two major factors currently driving emerging markets (EM). The first is falling inflation driven by lower commodity prices, which in turn is a function of weaker demand in China, as well as the normalisation of supply chains as the global economy has adjusted to the impact of the Ukraine war. However, in the medium-term, we do expect inflation to be more persistent.

The second big factor has been the abovementioned weaker than expected Chinese demand as the reopening boost has petered off. There are two reasons for this - firstly, there's uncertainty around housing and secondly, geopolitics has played a role in dampening consumption.

Performance review

We are marginally underweight Chinese equities and have been for the duration of the year. That said, our Chinese consumer holdings have underperformed the index. The names we own - including sportswear company Li Ning, dairy producer China Mengniu and even AIA Insurance, which has performed very well on the ground with robust double digit new business growth - have lagged the market.

Meanwhile, semiconductors names such as SK Hynix, TSMC and ASML have performed well. We remain invested in these companies given they are critical and well ingrained in global technology supply chains. They will also continue to benefit from the long-term structural shift towards high-end computing products, electric vehicles and AI.

Elsewhere, the Brazilian market has been quite strong on the back of expected interest rate cuts. Key holdings here include fintech firm Nu Holdings and car rental company Localiza.

Portfolio positioning

We have not had many changes over the last quarter or indeed year-to-date. One of the biggest additions to the portfolio has been travel luggage company Samsonite. The company has benefitted from travel resuming and is trading at around 10 times earnings, which looks attractive. We’ve also been cautiously adding to some Chinese consumer names where valuations look attractive and management teams are focused on improving shareholder returns. Elsewhere, given the strength of the recent tech rally, we have a taken some profit in this space.  

Outlook

EM as an asset class has derated significantly, particularly when compared to developed markets. Valuations remain relatively cheap, and we expect to see a rate cutting cycle which will likely stimulate domestic demand in many EM countries.

Despite the recent derating among Chinese stocks, we are not overly concerned and are reassured that buybacks are coming into play. Looking ahead, we expect the Chinese consumer to bounce back - there will likely be some stimulus measures and there is a high proportion of savings in China. As a result, we believe the backdrop in China remains positive. 

Overall, we are constructive on the outlook for EM. The universe still presents compelling opportunities, and our focus remains on owning well-managed businesses with strong balance sheets.

Important information

This information is for investment professionals only and should not be relied upon by private investors. The value of investments and the income from them can go down as well as up so clients may get back less than they invest. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than in other more developed markets. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes. Fidelity’s emerging markets funds have, or are likely to have, high volatility owing to their portfolio composition or portfolio management techniques. They 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. 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.