Improving outlook for emerging markets means that this trust deserves more time to come good
According to economist John Maynard Keynes, “in the long run we are all dead”. Indeed, investors do not have an infinite amount of time to build wealth before retirement, and ultimately death, inevitably occur. This means that their portfolio of investments must deliver high returns within a limited period.
Unfortunately, this fact can prompt investors to adopt a mindset that is unlikely to be conducive to high investment returns. For example, it can cause excessive risk taking that means they purchase fundamentally flawed assets in the hope of quick returns. It may also prompt short-termism that means investors do not give high-quality assets sufficient time to deliver on their potential.
This column, while mindful that no underperforming investment deserves to be held in perpetuity, nevertheless seeks to provide its recommendations with sufficient time to produce high returns. Although this can be frustrating at times, as in the case of the Fidelity Emerging Markets investment trust, the stock market’s track record shows that today’s underperforming shares are often tomorrow’s winners.
The trust has declined by about 18pc since we first recommended its purchase in July 2018. Since then, it has undergone major changes, with Fidelity replacing its previous manager Genesis in October 2021 as the company sought to improve performance. Having produced a 17pc share price decline over the past year versus a 4pc drop for its benchmark, the MSCI Emerging Markets index, it has continued to disappoint.
In Questor’s view, however, the trust deserves more time to deliver on its potential. After all, emerging markets have experienced a difficult period that is unlikely to last forever. They have become relatively unpopular among investors as a weakening global economic outlook has negatively impacted sentiment. And with the world’s largest emerging market, China, accounting for 36pc of the trust’s holdings (including Hong Kong), the country’s prolonged zero-Covid policy that was only ended in the latter part of last year has weighed on performance.
Encouragingly, emerging economies are widely forecast to generate higher rates of growth than their more advanced peers. While the IMF expects Britain and America to post growth of 0.9pc and 1pc respectively next year, it forecasts growth in China and India of 4.5pc and 6.8pc, respectively. With 53pc of the trust invested in the two countries, it is well placed to benefit from their growth potential. Indeed, it has a 7pc overweight to China and India versus the benchmark.
Although investor sentiment towards emerging economies may remain relatively downbeat in the short run as the full impact of hawkish global monetary policies takes time to play out, it is likely to improve over the coming years. After all, investors have never previously remained in “risk-off” mode in perpetuity and are likely to gradually seek riskier, and more profitable, investment opportunities as global inflation cools and interest rates reach a crescendo.
Under Fidelity’s management, the trust uses a bottom-up approach that seeks to identify the best emerging market companies irrespective of their sector, size, geography or whether they are included in the benchmark.
As a result, it currently has a 19 percentage point overweight to larger companies, which account for 85pc of its portfolio, compared with its benchmark. It also has a seven percentage point overweight to South Africa and an 11 percentage point overweight to financials. Since its portfolio is likely to differ materially from the index, it may experience marked underperformance or outperformance over all time periods.
The trust is also able to “short” stocks that it feels are fundamentally weak or overpriced. This further increases its overall risk and volatility relative to peers.
Trading at a 14pc discount to net asset value, the company is clearly highly unpopular among investors. In Questor’s view, its discount could remain at an elevated level over the short run as the popularity of emerging markets, and trusts that have historically lagged their benchmarks, remains at a low ebb.
However, its long-term prospects remain sound as emerging economies deliver high rates of growth and investor sentiment gradually improves. Given that the trust had a change of management about 18 months ago, this column believes it deserves more time to fulfil its potential.
Questor says: hold
Share price at close: 582.8p
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