1. What is your investment outlook for emerging markets in 2018?
2017 was a robust year for emerging market (EM) equities with the continuation of a number of appreciating trends which commenced early in 2016. Broad drivers of the market included: the stabilisation of commodity prices, a softening of the US Dollar versus its major trading currencies, synchronised global GDP expansion and attractive absolute and relative starting valuations.
Looking into 2018 I expect the majority of these tailwinds to remain in place though to a lesser extent than we’ve seen over the past 18 months. Global monetary conditions remain supportive for equities generally and that coupled with the benign inflationary backdrop, will likely result in a continuation of current conditions.
Equity valuations have rebounded from the lows seen in 2016 and as a consequence a large part of the cyclical recovery looks to have already played out. Future gains are likely to be derived from those companies with the ability to defend the underlying profitability of their businesses and deploy excess capital at attractive incremental rates of return. This will lead to a greater discrepancy of positive returns within EM equities and investors will need to focus on stock selection and valuation discipline in order to generate consistent absolute returns.
2. What do you think could surprise investors in 2018?
There remains a healthy level of skepticism towards the sustainability of the recent rally in emerging markets equities, particularly their outperformance versus developed market (DM) equities. I suspect that investors may turn out to be surprised by the continuation of these trends given my outlook comments above. This coupled with the fact that whilst the FED is likely to continue increasing interest rates, this may not lead to a material strengthening of the US dollar which would mitigate the impact to EM equities that many commentators currently predict.
On a more cautious note there remains significant financial risk in China due to the credit extension of recent years. Given the closed nature of the Chinese capital account, this risk remains manageable however a disorderly default or loss of control of the capital account would be materially negative for both EM and DM equities alike.
3. How do you plan to capture the best opportunities and add value for investors?
My mantra for the Fidelity Global Emerging Markets Fund is, and remains, ‘Prudent, Focused, Patient’.
Every company in the portfolio is required to meet high standards in corporate governance to ensure stakeholders are aligned and balance sheets need to withstand the vagaries of an economic cycle to help mitigate the risk of a permanent loss of capital. I also keep a keen eye on the sustainability of a company’s profit structure and critically the returns that the business is capable of generating through accretive reinvestment. Finally, I’m patient in allowing an investment thesis to play out, enabling the portfolio to benefit from the power of compounding in good businesses overtime.
The portfolio is positioned to benefit from increasing penetration and consumption of both discretionary and staple items across multiple end markets most notably China via domestic A share holdings. I expect Foshan Haitian and Shanghai Flyco to continue to deliver attractive reinvestment returns as they move up their respective value chains and increase market share due the competitiveness of their production processes which enables both businesses to deliver a high quality product at an extremely attractive price point to the end customer.
Financial companies such as HDFC Bank, Bank Central Asia and AIA Insurance, with dominant market positions which afford a cost of funding and credit risk advantage versus their peers also feature heavily within the portfolio. Additionally we also hold a handful of high quality businesses in Industrials, Health Care, Technology and Materials.
