2023 has been a volatile year for emerging market equities and whilst the macro backdrop is mixed, easing inflation and the start of rate cutting cycles point to a gradual improvement. Fidelity Emerging Markets portfolio manager reviews what lies ahead and outlines where he believes indiscriminate market moves have left selected high-quality businesses trading at attractive valuations.

What is your investment outlook for 2024 given the prevailing macro environment?

Emerging markets have continued to underperform developed markets. Weakness in China and concerns around geopolitics explain part of this, with both factors posing tail risks that we are scrutinising with vigilance. Nonetheless, the discount at which emerging markets are trading is at odds with the improving fundamental picture in many cases. This is especially the case given that inflation appears to have peaked in many economies, interest rates have started to come down and we are seeing many companies - particularly in China - return capital to shareholders.

The strong fiscal position of many emerging economies also stands the asset class in good stead. Unlike many developed countries, emerging markets were largely slow to extend fiscal subsidies during Covid lockdowns. We see lower levels of debt-to-GDP in many emerging market countries, particularly relative to the US, where the near-breaching of the debt ceiling brought the country’s unsustainably high levels of debt into sharp relief.

What do you think could surprise markets in 2024?

As the largest single market in the emerging market universe, China plays a central role in driving sentiment towards the asset class. Its capacity to ‘surprise’ markets was apparent when the country’s economic reopening post pandemic spurred a rally in markets, only for this to unwind as it became clear that the recovery would be slower than anticipated.

We believe that consumption in China will recover, largely given the excess level of savings among households. We are also mindful that the sell-off in China has been particularly severe amongst Hong Kong listed Shares; market moves could be more pronounced here if confidence improves. Given these factors, and the scale of the market, a change in sentiment has scope to influence emerging market returns significantly.

Elsewhere, we see pockets of the market overlooked; dispersion is very broad, with valuations trading at very different levels if you compare emerging Europe to India, for example. This throws up some opportunities and offers the potential to unlock attractive shareholder returns in the year ahead.

Geopolitics remains a tail risk for markets. We are focusing on staying fully engaged and speaking to people with a range of different perspectives, seeking to bring more voices to the table and calling on geopolitical experts and external strategists to help us make sense of the elevated unpredictability we see in markets.

What has worked well in your portfolios over 2023?

This year has seen rapid swings in market sentiment, resulting in sharp rallies followed by bouts of profit taking. This is exemplified by the information technology sector, where a difficult 2022 was followed by exuberance surrounding the bottoming out of the semiconductor downcycle and the AI-driven rally. Some of our holdings in Taiwan and South Korean technology hardware did particularly well over the period. Here, it has been important to trim and take profits in a disciplined manner as share prices rise.

Other strong performers this year include holdings in the financial sector. Here, our ability to traverse a broad investable universe and examine underexplored areas has paid off. Ecommerce and payments platform Kaspi and Brazilian challenger bank Nu Holdings have been standout performers. These are names were unearthed as a result of intense bottom-up research.

Past Performance %
  Oct 2018 - Oct 2019 Oct 2019 - Oct 2020 Oct 2020 - Oct 2021 Oct 2021 - Oct 2022 Oct 2022 - Oct 2023
Net Asset Value 20.7 4.3 10.5 -28.6 2.6
Share Price 23.1 5.7 6.4 -31.7 5.7
MSCI Emerging Markets Index 10.9 8.7 10.7 -17.9 5.1
Past performance is not a reliable indicator of future returns.
Source: Morningstar as at 31.10.2023, bid-bid, net income reinvested.
©2023 Morningstar Inc. All rights reserved. The MSCI Emerging Markets Index is a comparative index of the investment trust.

Where are the key areas of opportunity in 2024?

We continue to see opportunities in the financial sector. We do, however, think that the boost that banks have had from rising net interest margins has largely played out and we are looking to shift focus from higher-rate beneficiaries to those that benefit from structural drivers. These include structural ‘growth’ stories like Indian banks, which operate in an underpenetrated market that should see rising demand for products like credit cards and savings accounts, as well as structural ‘change’ stories like Greek banks, where a decade of very low loan growth has resulted in many banks with excellent asset quality.

Conversely, China property will not be the strong driver of economic growth that it has been in the past, which has a knock-on effect on consumer confidence. But we do see significant value in China and a growing prevalence of companies that are returning capital to shareholders. China Mengniu Dairy, Zhongsheng Group, Vipshop and AIA Group are just some examples of companies with progressive buyback policies that are trading on very attractive valuations given weak sentiment towards the Chinese market.