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2019 performance commentary
Despite such volatile market conditions, in 2019 the Fund solidly outperformed the benchmark. This outperformance was primarily driven by stock selection, both at the country and at the sector level, lending support to the strength of the investment process in selecting long-term winners.
Source: Fidelity International. Portfolio = Fidelity Global Emerging Markets Fund. Performance is shown net of fees in AU dollar terms, as at 31 December 2019. Comparative index is the MSCI Emerging Markets Index (net, total return).
At the sector level, the largest contribution to performance came from stock selection in Consumer Discretionary and Financials. Within the former, Chinese names were the key drivers of returns. In this context, the leading Chinese sportswear brand, Li Ning, was the top contributor for the strategy. The company posted exceptionally strong results throughout the year, whilst continuing to show improvement in all the key financial and operation metrics. Investors also welcomed the announcement of its new co-CEO. Other noteworthy performers within Consumer Discretionary were Zhongsheng Group (autos), Zhejiang Supor (cookware) and Midea Group (white goods).
Among Financials holdings, allocation to Chailease, the Taiwanese lease financing provider, to Indonesia’s Bank Central Asia, and to Tisco Financial, the leading Thai auto loan bank, boosted returns.
At the country level, China was the largest contributor to performance. Despite a volatile year for the Chinese market, driven by ongoing concerns regarding the direction of the trade dispute with the US, the strategy’s stock selection was strong. Alongside the Consumer Discretionary holdings previously mentioned, allocation to selected Consumer Staples names also aided gains - among these are Foshan Haitian (flavouring) and China Mengniu Dairy (dairy).
In terms of detractors, some I.T. names weighed on relative returns. Exposure to Cognizant hurt performance. Sentiment towards the US-listed I.T. services company was negatively impacted by the CEO change and management transition. We nevertheless maintain conviction in the name, as its margin structure provides it with a competitive advantage of investing in new technologies and driving industry change. Elsewhere, limited exposure to Samsung Electronics weighed on returns, as the market started showing signs of demand recovery and supply discipline, and as the acceleration of 5G deployment lent further support. However, in this context, allocation to Taiwan Semiconductor (TSMC) aided performance.
At the stock level, Alibaba emerged as a detractor, as the strategy’s limited exposure to the stock weighed on returns. As it will be outlined in the following section on positioning changes, this has been increased throughout Q4 in light of increased conviction in the name.
At the portfolio level, the fund continues to maintain a sizable exposure to consumer and financials stocks. The focus remains on owning well-managed business with attractive return profiles, an accretive reinvestment opportunity and a valuation that offers an adequate margin of safety on a free-cash-flow basis.
Emerging markets continue to offer many opportunities, supported by structural growth drivers such as urbanization, lifestyle changes and the rising purchasing power of EM. We hold businesses that can capture this trend. In Q4, the portfolio added a position in Alibaba. This reflected increased conviction in the company’s corporate governance structure’s alignment with minority shareholder interests, but also a positive outlook of the stock. Alibaba continues to benefit from the structural shift to online retail and from increase in the take-rate on merchandise sales, where we see scope for considerable room for expansion when compared to global peers. Moreover, the online-retailer is also set to benefit from growing segments such as the Cloud and financial services. Elsewhere in consumer discretionary, we trimmed the position in Li Ning, following a particularly strong share price performance. In consumer staples, we exited the position in AVI, on the back of a weaker macroeconomic environment in South Africa weighing on the consumer space.
We continue to find financials an attractive sector, given the balance sheet quality of dominant, privately owned, retail-facing banking models, as well as the significant growth opportunities, driven by the prevailing low credit penetration levels. An example is Bank Central Asia: the 3rd largest bank by assets in Indonesia, it benefits from a leading position in retail and an entrenched cash management business, which enables it to capture a large market share of payroll accounts. This translates in a best in class deposit franchise, providing an abundant source of low-cost deposits and a buffer to weather economic volatility. In the second half the year, we reduced our exposure by trimming positions in the likes of Itau Unibanco and Housing Development Finance, to reflect an environment characterized by lower global interest rates. Nevertheless, it is important to mention that the opportunity sector in Financials remains strong as, unlike developed economies, emerging markets enjoy high real interest rates.
Throughout Q4, the decision was also taken to increase exposure to industrials, by adding new positions in Lonking Holdings and Weichai Power in China. Lonking Holdings is a leading manufacturer of wheel loaders and forklifts and is set to benefit from a cyclical improvement in demand in construction. The company also exhibits a double-digit dividend yield profile and a strong balance sheet cash position. Weichai Power is the largest heavy-duty truck engine maker, benefitting from a consolidating industry and growing market share. In Communication Services, the strategy exited the position in China Mobile Limited.
At the country level, throughout 2019, the investment team found some attractive investment opportunities in Russia, adding positions in Severstal, Lukoil and X5 Retail Group. Not only are these companies characterized by solid fundamentals and growth opportunities, but the the Russian economy also provides them with a benign macroeconomic backdrop, with relatively high levels of international reserves and a twin surplus in its current and budget balances.
Elsewhere, the overall exposure to the A-Share market was reduced throughout the year, reflecting the trimming of positions in strong performers, namely Midea Group, Zhejiang Supor Cookware and Foshan Haitian, and the reallocation of capital to other pockets of the market.
Looking forward, certain factors have emerged, that have the potential to support sentiment as 2020 progresses. Synchronised easing from central banks, growing potential for a US-China trade deal, as well as reforms in parts of the global economy (i.e. Brazil and India) are just a few examples, which could help unshackle growth potential.
As we look forward, investors will continue watching closely the interest rate environment, both in the US and across the EM investment universe. Overall, cuts are expected to lend some support to improving economic conditions (although from levels). Confidence in global growth rebound is indeed also on the rise, as governments across EM and DM have embarked on fiscal policy changes to drive opportunities. In this context, trade is expected to continue to create headlines in 2020, with the amelioration of US-China trade tensions being key in restoring investor confidence. Downward pressure on the renminbi is also expected to ease on the back of these developments.
However, the US dollar remains a conundrum, posing a risk to the asset class in the case of a sharp appreciation. In face of heightened volatility, it has been perceived as a safe heaven, representing a potential headwind. More recently, EM FX has edged higher supported by abating social protests in Latin America and US-China trade developments. Such factors coupled with a US twin deficit which should be more conducive to a weaker dollar over the long-term and a more positive backdrop for EM currencies.
As stated in previous commentaries, emerging markets continue to exhibit compelling valuations, trading at significant discount to developed markets. The valuation gap between EM and DM is trading at its widest in 15 years; -35% on a price-to-book basis (Figure 1). Looking at the year ahead consensus estimates place EM earnings growth above DM, providing reason to feel positive about the year ahead.