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The reason emerging markets are looking very attractive now

14 December 2018

Fidelity International's Nick Price gives his outlook for emerging markets and explains why he is bullish onthe sector heading into 2019.

By Maitane Sardon,

Reporter, FE Trustnet

Valuations in emerging markets are at levels not seen since the global financial crisis, providing very attractive levels of potential upside, according to Fidelity International’s Nick Price.

FE Alpha Manager Price, who manages the £2.2bn Fidelity Emerging Markets fund, said low valuations are good news for investors, as there are plenty of reasons to be positive about emerging markets in 2019.

Emerging markets have faced three principal headwinds in 2018 – a hawkish US Federal Reserve and strong US dollar, the trade war and a decelerating Chinese economy.

This, has pushed valuations and sentiment towards multi-year lows.

But whilst some claim the worst of this weakness may now have passed, the currency background remains a potential threat in 2019, particularly for those countries most reliant on commodity imports or external financing of current accounts.

Performance of indices YTD

 

Source: FE Analytics

“We have an enormous portion of the market which, if the US is rising rates, those higher rates are inflicted on the emerging markets and that issue is amplified further because it affects the trading partners of those nations,” Price explained.

One example of the extremely low-level valuations seen across the region is the de-rating of China A-shares, which Price noted has happened without significant reset of earnings growth.

“There has been an enormous multiple derating across China in 2018 and particularly A-share markets,” said the manager. “That does provide opportunities, but it will also require some signs of stabilisation in the Chinese consumer market.

“Largely, the A-share market attracts domestic investors that, I hate to say it but are rather uneducated investors. So, you see a lot of volatility around that, which ultimately does provide some opportunities.”

As the chart below shows, the MSCI China A Onshore index has fallen by 23.27 per cent in 2018, so far.


Despite faring poorly in 2018, however, Price said investors cannot afford to ignore the size of the Chinese stock market.

He added: “For you to have an idea of its size, the Chinese A-share market is $6trn market cap, it is the third largest stock exchange in the world.

“And, although it’s 0.5 per cent of the total of the MSCI Emerging Markets index, this will increase over time and will get to 15 per cent.”

Performance of index YTD

 

Source: FE Analytics

The fund manager noted that China also plays a significant role in the economies of other emerging market countries as a major trading partner.

The escalating trade war between the US and China continues to plague investors and is seen as a material issue by Price, although he said an improvement is likely in 2019.

“I am a little bit more hopeful on the US-side of things, I think we will see some level of amelioration and indeed I don’t think the US can live with significantly higher rates,” noted the manager.

According to Price , investors should expect increased competition, increased transmission of ideas and increased capital profitability in 2019.

As such, the manager said he remains focused on his investment approach to take advantage of any potential recovery in markets.

“As ever, our focus remains on identifying good quality companies, which can deliver attractive shareholder returns over the medium to long-term, with the view that fundamentals reassert in time,” said the Fidelity Emerging Markets fund manager.

“We spend a lot of time looking at the supply side. We look at net supply of food retail space, we make comparisons towards developed markets and we try to make sure that we don’t invest in areas that may or not may become oversaturated through trade, increase competition, etc.”


 

He added: “We do tend to look longer-term and a big feature of the process is looking at the capital expenditures of the companies and looking at the marginal returns on that capital to make sure they are sufficient.”

Another issue the team continues to monitor is equitable shareholder treatment in emerging market companies, which he said remains a huge issue and is something that needs tackling: “We have around 65 names in the portfolio and we have full engagement at the board level in terms of looking for returns on capital to shareholders.”

Elsewhere, the Fidelity manager noted when looking at commodity-related businesses such as miners, pulp and paper, certain fertilisers and the energy complex, there’s been very little in the way of investment post the global financial crisis.

However, he said these companies have been run for cash, and are starting to return cash to shareholders.

“Amongst the mining and energy companies we favour, dividend yields are high. And so, if we see reacceleration or sustained growth across the globe, there is the chance that we see a significant move-up in some of these commodity areas,” he said.

 

Under Price, the four FE Crown-rated Fidelity Emerging Markets fund has delivered a 72.51 per cent total return compared with a 44.98 per cent gain for the average fund in the IA Global Emerging Markets sector and a 56.14 per cent rise by the MSCI Emerging Markets index.

Performance of fund vs sector & benchmark under Price

 

Source: FE Analytics

The fund has an ongoing charges figure (OCF) of 0.96 per cent.

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