Understanding what drives returns matters

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  • The value of Argentine equities tends to be much more driven by the direction of bond yields/equity discount rates than fundamentals, especially since they have started from such an extreme level.
  • The direction of bonds/discount rates in Argentina is driven by political outcomes which we have, in my view, an inability to forecast with any degree of precision.
  • The Fidelity Global Emerging Markets strategy hasn’t had direct exposure to Argentina as a result, and I see no reason yet to change that stance today.

The returns an investor can expect to derive from an equity are essentially broken down into:

Endogenous factors, which are largely within the control of the management team of the company in question: the decision to invest in a new factory, open a new store, launch a new product, lower costs of production, invest in research and development, and ultimately maintain competitive positioning. We can research these areas, model ranges of outcomes and ascribe probabilities on each given outcome to determine the risk-adjusted cash flow profile of a company.

Exogenous factors, which are outside of the management team’s control: exchange rates, commodity prices, interest rates and politics. Each of these are driven by a whole range of different factors which are very hard to predict, ascertain ranges of possible outcome for and have a degree of conviction in the most likely outcome. As a result, I tend not to invest in businesses where the primary driver of equity returns is exogenous.

Equity discount rates in Argentina have always been relatively high (this is due to the historic economic and political volatility, high inflation, etc.). As a result, the single biggest driver of equity returns is the direction of the bond yield (and equity risk premia) and the valuation of the currency. It is largely irrelevant what any of the individual companies do at a single stock level. When the starting point for equity risk premia and absolute yields is so high, the only thing that matters in terms of driving the stock price is whether the bond yield rises or falls; that is, you stand to make, or lose, all of your money on the equity discount rate increasing or decreasing.

Until recently, the market assumption was that the politicians in Argentina would pursue fiscal and monetary stability and yields were priced to continue declining. As a result, Argentine bank stocks (which are the most sensitive to changes in bond yields) appreciated by 83% from 1 January 2019 to 11 August 2019. This increase was purely driven by perceived changes in discount rates applied to bank returns. On Sunday, they fell by 55% as the market repriced Argentine risk assets for the likelihood of a populist government.

In my view, we have very little insight into which outcome is most likely to prevail – other than taking a guess. As a result, today I am reluctant to make any changes to the portfolio when it comes to Argentine exposure.

Performance, net of fees (%)

  1 year 3 years 5 years Since inception
Fund 18.10 15.93 12.00 11.37
Benchmark 5.51 12.01 8.13 8.24
Excess Return 12.59 3.92 3.87 3.13

 

 

 

Source: Fidelity International, Fund = Fidelity Global Emerging Markets Fund. Benchmark = MSCI Emerging Markets Index NR. Performance is shown net of fees, in AUD dollar terms at 31/07/2019. Fund inception date = 16/12/2013. Please note that past performance is not a guide to future performance. Returns of the Fund can be volatile and in some periods may be negative. The return of capital is not guaranteed.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment. Investments in small and emerging markets can be more volatile than investments in developed markets.

This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information.  You should also consider the relevant Product Disclosure Statements (“PDS”) for any Fidelity Australia product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading it from our website at www.fidelity.com.au. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise. 

© 2019 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited.

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