11th October 2016

Fidelity Perspectives: Three things to watch in EM

As sentiment towards emerging market improves, strong passive flows have resulted in some of the poorest quality stocks delivering high returns because they are large constituents of the index. Nick Price, portfolio manager of the Fidelity Emerging Markets Fund, does not believe in buying index names unless there is a solid investment thesis for the business. He highlights stocks in three areas of the market that he believes are well placed to benefit structurally from the improved outlook for emerging markets.

The customer is king

The consumer sector remains the area that the Fidelity Emerging Markets Fund is most heavily exposed to; and our holdings across both the discretionary and staples sectors cover a very broad range of businesses that are all expected to benefit from the growing middle class in emerging markets and the formalisation of employment and retail. FEMSA, the Mexican consumer discretionary name, has detracted from relative performance as devaluation of the peso had a big impact on returns. However, the underlying investment thesis remains intact. We expect earnings growth north of 20% to be driven by Oxxo (their equivalent of the 7-Eleven store format).

We acknowledge that Mexico remains vulnerable in the near term if Donald Trump prevails in the US elections. However, following a trip to Mexico in early summer we added exposure to Grupo México, which is a copper business and should provide a good hedge if the Mexican peso weakens somewhat in the event of a Trump victory. Elsewhere, we have added to consumer staples names which have been impacted by short-term news flow resulting in a de-rating to attractive valuation levels.

Notably we have built up a position in Korean cosmetics company Amorepacific when it was impacted by concerns on duty free policy, which could restrict sales volumes. It is a stock we’ve owned in the past and has a very long term growth trajectory.

IT

I am still positive on the IT sector, despite the fact that it has been a big negative for the fund’s performance in 2016. One of the biggest detractors has been Samsung, which we don’t own. It constitutes around 4% of the benchmark and has been influenced by ETF flows as well as investors anticipating a better outlook for their smartphone business. Nevertheless we remain of the belief that the smartphone value chain has peaked and that Samsung remains squeezed between Apple and some of the cheaper Chinese suppliers.

The second part of IT that has hurt us is the Indian outsourcers. This includes companies like Cognizant and Infosys that employ workforces in India, providing software implementation and support to many European and US companies. These companies were marked-down following the Brexit vote as there is far greater uncertainty surrounding the outlook for financial services and some of the European implementation projects have been put on hold. The companies have now de-rated and are trading at the very bottom of their trading ranges, and given they are very asset light businesses I believe they offer compelling value at this stage.

Africa going global

I maintain significant exposure to South African names, albeit at a reduced level as I have some reservations about the retail environment. This position should not be perceived as a pro-cyclical view on the country, rather it is a view on some of the companies operating out of it. The country’s largest companies are more exposed to global rather than local dynamics, and as such we invest primarily in a number of businesses which have a particularly strong track record in overseas expansion. In that context, I have trimmed the holding in Woolworths as this has a higher domestic South Africa exposure than the likes of Steinhoff and Naspers.

Steinhoff is the second-largest homeware retailer in Europe after Ikea. It is a great example of a firm pursuing a successful acquisitions-driven business model, with vertical integration of subsidiaries allowing it to maximise synergies. The company continues to diversify internationally and I expect their recent acquisition of a mattress business in the US to be very accretive over the medium term.

Investment Commentary, Investments