As tragic events continue to unfold in Ukraine, Fidelity Emerging Market Equities portfolio manager Nick Price shares his latest investment views. He discusses how market dynamics are evolving across the developing world and provides an insight into current portfolio positioning.

Key points
 

  • We have adjusted down the fair values of our Russian exposures in our portfolios given that there is no meaningful price discovery taking place in the Russian market.
  • Commodities will continue to be subject to huge inflationary pressures, which supports our overweight positioning in metals, mining and energy.
  • The global squeeze on the consumer will translate to the emerging world. Given this, we have moved to reduce our consumer discretionary exposure to an underweight position.

Russian market update

At the outset, we’d like to emphasise that our foremost thoughts are with those directly affected by the horrific war in Ukraine. We remain hopeful of a swift resolution to the crisis. This has clearly already had a significant impact on economies and markets over recent weeks. Looking at our portfolios, we have moved to adjust down the fair values of our Russian holdings as there is no meaningful price discovery taking place in the Russian market at present.

In terms of activity, we sold some exposure at the outset of the invasion, but liquidity deteriorated very quickly as trading was banned in local Russian lines. As a result, our portfolios are left with some residual holdings, although we do not consider these to be economic exposures at this point in time.

We've spoken to all the Russian companies we have held recently. The key takeaways are that Russia is still selling commodities to the world, albeit slightly less than usual, and it is still being paid. Speaking to Sberbank, SWIFT is still working and the company are receiving payments for commodities. As a result, it doesn’t look like Russia will be starved of foreign currency, despite it having been blocked from accessing a significant portion of its foreign exchange reserves.

Private businesses have suspended dividends (Phosagro and NLMK), with the broad message being that they want to treat all shareholders equally, rather than pay out to some and not to others. Some companies like Sberbank and TCS are in survival mode and need to preserve their capital levels, so have cancelled their dividends. On the other hand, large state-owned companies like Gazprom have stated clearly that they will continue to pay dividends to all shareholders, albeit these will be held in escrows account (in Russia, in rubles) for the time being. The litmus test will be in late July, when Gazprom’s dividend is due to be paid.

Views on commodities

The global reliance on Russia for oil and gas production means that commodities will continue to be subject to huge inflationary pressures, with no let-up in sight. As the war continues, other commodities such as wheat, corn and metals will be affected as physical supply-chains deteriorate or cease functioning, driving a huge squeeze in prices.

We already had decent positions in materials across our portfolios, especially in metals. We have large copper exposures via Grupo Mexico and First Quantum. We also have Sibanye in PGM - gold. We have added about 120-130bps across this complex via a few names, but we can’t mention these specifically.

There is a dearth of good ideas in the emerging market energy space. For context, Aramco is now a US$2tn stock trading at 20x earnings, with the assumption of US$100 oil prices. These are not the kinds of valuations that I consider attractive on a through-cycle basis. Overall, our aggregate position in metals, mining and energy is approximately 150-200bps overweight.

In terms of second-order effects, the main one will be the global squeeze on the consumer. The magnitude of the impact on Europe alone is likely to be in the order of a US$1tn tax. This will translate to the emerging world and we have therefore reduced our consumer discretionary exposure to an underweight position.

India and China spotlight

India is particularly sensitive to commodity prices. We were already conservatively positioned in India, but have reduced life insurance via HDFC limited. HDFC Bank and Infosys are trading well and we believe these businesses are relatively well positioned, so we are not too concerned with our overall India exposure at present even though it is perhaps one of the most susceptible to the crisis.

In terms of China, I’m not sure the war has played a huge role in market moves over the last couple of weeks, although there have been some headlines of Russia trying to source military supplies from China. We have seen companies like BP and Shell divesting Russian assets and I therefore think that the moves are more associated with the risk of the delisting of US-listed Chinese stocks (ADRs), as well as further regulatory scrutiny being put on Chinese businesses like WeChat. We are well positioned in this space, with little exposure to these dynamics; we are significantly underweight Alibaba and reasonably underweight the Tencent complex.

The most successful sanction to date has been the freezing of the Russian central bank’s assets. As a result, I think that countries like China, Saudi Arabia and the UAE will be rethinking how they hold their forex reserves. They will not want to find themselves in the position where the reserves they have built up over years are taken away in the future. The overall geopolitical effect of these developments could weigh on the dollar, but it is impossible to be unequivocal and I still expect the dollar to hold up well during periods of uncertainty.

Summary

As long as the war persists, there will be significant pressure on consumers globally and an inflationary recession seems likely. We can only hope that peace talks are successful, but the lack of trust, particularly in Russia, is unfortunately making this outcome look improbable at present.

Certain emerging markets will find things difficult, but commodity producers might be relatively well buffered. Europe will have a difficult time, both as a result of the direct impacts of the war and also the need to increase defence spending, which will crowd out spending elsewhere.

In terms of positioning, we are content with our allocation to the materials sector. We have a large position in the technology supply chain, which is driven by the shift towards electric vehicles and artificial intelligence. We expect these areas to be relatively well insulated, although there will be second-order implications for consumer electronics (where our exposure is low). These two areas make up just under 50% of our long-only portfolios.

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