Fidelity Emerging Markets 02 June 2023

Fidelity Emerging Markets Limited (LON:FEML) hands the managers a full set of tools with which to create a highly active investment proposition with high alpha-generating potential. Not only are the managers free to invest anywhere on and off-benchmark, across sector, market cap and geography and into the frontier markets, but they also make use of derivatives in multiple ways, most importantly to take up short positions in companies.

FEML’s strategy mirrors that of the open-ended Fidelity FAST Emerging Markets fund, which has been managed by Nick Price since launch in 2011. Long-term returns have been well ahead of the benchmark (see Performance section). Nick was joined by co-manager Chris Tennant in 2019, meaning the pair have 11 and four years’ experience on the strategy respectively, and they took over FEML when the management contract was awarded to Fidelity in October 2021.

Many funds claim to be active, but the options available to FEML really make it stand out. In the long book, the managers use Fidelity’s extensive research team to identify high-quality companies with good growth prospects and attractive valuations. Nick and Chris also short the weakest companies, whether that be an idiosyncratic short or a pair trade (see Portfolio). They can take geared positions with derivatives too, as well as buying or selling options to generate extra returns.

Emerging markets were out of favour in 2022 – and equity markets in general saw poor returns. FEML also had a bad year. This has led to a wide Discount opening up, relative to the trust’s history and relative to the peer group, while the board has committed to a conditional tender offer in five years and remains active in looking for ways to close it. (We note that technically, FEML is a Guernsey-registered investment company, but we will use the term trust for simplicity’s sake.)

Emerging markets have underperformed the US, and therefore global developed markets, for over a decade, with only short periods of outperformance. US markets have become extremely expensive as a result, with the US dollar also looking expensive. Yet after China’s reopening in Q4 2022, there are signs that market leadership has shifted. Emerging markets have outperformed and the dollar has weakened. With emerging markets looking cheap, this could be a good time to buy. An additional factor favouring FEML is that the impact of higher rates and therefore the higher cost of debt should increase the pressure on weaker companies. FEML can take advantage by shorting these stocks, and to us it looks like this could be a conducive environment to this strategy, and one which makes FEML less dependent on market direction for returns.

In our view, FEML is a premium product which, due to a combination of macro circumstances and recent underperformance, is available on a highly attractive discount. A rising dollar and high risk aversion meant that 2022 was a poor year for emerging markets, while the Russian invasion of Ukraine and a shift from growth to value worked against FEML. The discount of 14.3% at the time of writing looks highly attractive to us given the managers’ strong track record. This is particularly so given the tender offer and continuation vote scheduled in years to come (see Discount). In the past, the strategy has been an alpha-generation machine, with some inevitable variability as to when this is generated.