Don’t worry if you missed this week’s virtual event with Fidelity Emerging Markets (FEML ) co-manager Chris Tennant, you can watch the whole 56-minute recording here.

In the broadcast, Tennant explains how he and lead fund manager Nick Price run the £600m investment trust and why the long-term growth story in emerging markets is good value right now, particularly with FEML shares trading on a 15% discount to net asset value.   

Can’t watch now? Read the transcript!

Gavin Lumsden (GL):

Hello and welcome to ‘Maximising Opportunities in Emerging Markets’ a one-hour programme brought to you by Citywire and Fidelity International. My name is Gavin Lumsden, I’m from Citywire. With me in the studio is Chris Tennant, co-manager of Fidelity Emerging Markets Limited, a £600m investment company listed on the London Stock Exchange. Chris, very good to see you.

Chris Tennant (CT:

Thanks for having me.

GL: At a time when recent concerns over banks in the US and Europe have reminded us of some of the hidden risks in developed markets, it’s good to learn about the emerging markets, which while clearly not risk free, are arguably backed by more positive and fundamental drivers for growth. Chris is going to tell us about these, and the flexible go-anywhere approach he and co-manager Nick Price take to their task. Let’s get down to business.

CT: Thank you, Gavin, it’s great to be here. This slide really outlines the resources available to the Fidelity Emerging Markets Limited company, which I’ll refer to as FEML throughout this presentation. So Nick Price is the lead portfolio manager, who’s been at Fidelity for around about 25 years and he’s been running the strategy on which FEML is based, which is called the FAST EM Fund , since 2011. I’ve been at Fidelity for approaching 12 years. Initially, I was an analyst covering a number of sectors, including industrials, metal and mining, before transitioning to the portfolio management team. The most important resource that we outline on this slide is the equity research component. So we have around about 250 research professionals at Fidelity and 62 of them are dedicated to emerging markets.

They’re based locally in the regions that they cover and they’re really covering their sectors from a bottom-up basis, meeting their companies, the competitors, the supply chain. Boots on the ground conducting that due diligence for all of the stocks that they cover. So that is the fundamental resource in which FEML draws its ideas from. So, if we move on to the next slide.

Boots on the ground

So why Fidelity Emerging Markets Limited? Firstly, as I mentioned, it’s that local presence. We’ve got, I think, an unparalleled research team that’s generating these ideas. They’re based in local domestic markets, as I mentioned, whether it be Mumbai, Hong Kong, Singapore. So, they’re really close to the companies which they cover and doing a great level of analysis and research and meeting those companies regularly. The way that we’d divide this research team is by sector. So, for example, we’ll have a Chinese autos analyst and their job is to have the greatest level of knowledge in that specific field and that helps them cover those stocks and identify investment opportunities. The next reason why we think that Fidelity Emerging Markets Limited is a fantastic opportunity is the asset class itself.

I think it’s a fantastic structural asset class. Almost two-thirds of the world’s GDP growth now comes from developing markets. So, it’s a huge growth driver. Not just are they growing in terms of population size and have those strong demographic trends, but you have a transition to middle-class consumption. So, credit penetration, consumption of goods is growing even more quickly. So, there are a number of fantastic growth opportunities to take advantage in this vehicle.

Finally, the portfolio’s extensive investment toolkit. So, the nature of the trust allows us to go down the market cap spectrum. So, it’s not just the liquid large-caps that we’re looking at. The research team, combined with the nature of the investment company, allows us to find these uncovered gems that are, perhaps, not covered by the sell-side or our competitors.

Finally, there are various investment tools of the investment company. Not only can we long, but we can also short. So, this analyst team, as well as several shorting analysts will look for structurally losing businesses or companies with balance sheet or accounting concerns that we can short sell as well. So, we can profit from both winning companies and losing companies in this vehicle. So, it really is a fantastic way to get exposure to that structural emerging market trend. So, if we move on to the next slide, please.

So, there’s a lot of on-the-ground research. I just came back from a trip in Mexico, where we were meeting a number of companies out there, which is quite pertinent, given the nearshoring trends. There are a lot of companies in Mexico that are benefiting phenomenally from the shift in supply chains, away from the likes of China, towards countries closer to the US. This trip that we highlight here, was one that we conducted last year to Brazil. There was eight of us that went on the trip. So, several of the portfolio management team and a number of analysts as well, covering their specific sectors. We conducted almost 40 company meetings while were out there. Meeting a number of different industries. It’s really that boots-on-the-ground research that there’s no replacement for and it’s incredibly important to get to these countries to mee with the companies.

There’s an example of some of the other trips that we’ve done last year. South Africa, Middle East, Indonesia, India and next month, I’m planning to go to Poland. So, it really is a very key part of the process. Fidelity as a whole, conducts 16,000 company meetings a year. I’m told that that equates to one every eight minutes. So, we’re really doing a lot of personal research, meeting these companies and the industries in which they operate. If we could move on to the next slide, please.

Great growth story

So, the growth opportunity. As I mentioned, emerging markets, and developing economies count for over 60% of GDP growth today. So, it really is the growth engine of the world’s economy. That is driven primarily by, not in all emerging markets, but on the whole, growing populations. So, you see working age populations in a lot of emerging markets still growing rapidly. A lot of the world’s manufacturing is transitioning to these countries and there’s a lot of companies that benefit as a result. On the right-hand side here, you have the increase in consumption that we’re expecting from 2015 to 2030. 200% growth we highlight in the Asia Pacific region. So that increase in consumption is an enormous tailwind for a lot of the companies for which we cover. This doesn’t just benefit the consumer companies, but also, the banks and financial services industry that lend money to these consumers. So, it really is a great structural growth story.

I guess this is the more cyclical outlook for emerging markets. I think it’s not just a great structural growth story, but at this point in time, it’s a great opportunity to get exposure to the region. It’s had a tough period for performance and the two charts on the left really show what has happened in terms of a derating of the asset class and the valuation of emerging markets relative to developed markets. It’s close to all-time lows. So, I think from a valuation perspective, it’s a fantastic entry point. Then from a top-down macro standpoint as well, I think we’re very deep into the tightening cycle in the US. We think we’ve already seen peak inflation and those interest rate hikes that we’ve seen from the Fed, that have weighed on emerging markets in recent years, we think are coming to an end.

I think what’s quite different from this cycle to previous cycles, is that emerging market central banks have been much further ahead of the curve. Much more proactive in hiking interest rates than they have done in prior rate hiking cycles. So, if you look at the real interest rates. So the policy rate minus inflation in countries like Mexico and Brazil, they’re at extremely high levels. So, when we do see interest rates start to come down in developed markets, there’s a long way to fall in places like Brazil and Mexico. That has been a huge burden on the consumer in these countries. That will be easing, we think, over the next 12 to 18 months. Finally, on the cyclical tailwind side of things is the reopening of China.

So China has had, not just from the Covid policies, but from tightening regulation generally, in the tech sector and the property sector, a number of headwinds over the last couple of years. We really think we’ve seen most of these headwinds reverse and China’s obviously now reopening. So, you have that boost from an increase in mobility in China as well. So really, the structural growth angle to emerging markets and I think, a cyclical argument as well to be had, that this is a fantastic time to become invested. So, move on to the next slide, please.

Shorting stocks

So, the Fidelity Emerging Markets Limited toolkit. This slide really outlies the difference in approach of this company versus a more traditional fund. So, on the right-hand side, you have a traditional fund which will have typically, about 100% exposure to long-only investments. We extend that long-only from 100 to typically, about 130. Against that, there is a short position, which will typically represent about 30% of assets as well. So really, your single dollar invested in this product is working much harder for the investors in this company. The active management is extremely high. Of course, that allows us to benefit from not just winning businesses on the long side, but also, losing businesses on the short side of things.

[TEN MINUTES]

So, I’ll talk a little bit more about the short book. There are two buckets that these short ideas will fall into, which we’ll go into a couple of examples in a second. Firstly, they’ll be the more idiosyncratic shorts that are broken businesses where we see red flags around accounting, corporate governance, regulation, perhaps fraudulent activities. So, a stock specific short idea. Then there’s the pair trade. So, when we identify a winning position in a particular industry, often they’ll be gaining a lot of market share and that means that there are market share losers in that category as well. It’s one of the things we look to do is identify those losers. So, we have these pair trades where we will own a market share gainer and short a market share loser in the company. Finally, we can pursue opportunities in unlisted companies, but it’s not something that we’ve done to-date. So that summarising the key tools available to the company.

India banks

So, I’ll start off with one of the core long positions. This touches on a number of the themes that we’ve talked about already. That’s the Indian banks. India, in general, is quite an expensive market, if you were to look at a typical consumer staple and compare it to a like-for-like business in developed markets. Where we see a lot of opportunity is in the banking space. Actually, HDFC, which has been a core holding for the strategy for over a decade, is today, trading at a discount to the Indian market in general. It’s the first time that that’s happened in a decade. So, the valuations have started to look extremely attractive. India has not had a capex cycle for the last ten years. So, we’re, I think, going into a period of strong demand for loan growth.

Driven not just by corporates and capex, but also, the consumer. So, this chart here, you can see India in the bottom left-hand corner. Quite low credit penetration as a percentage of GDP. Low GDP per capita and we think both of these things can grow structurally over the coming decade. So, it’s a very long duration growth opportunity. HDFC is a fantastic bank that has extremely high-quality loan writing. So, it’s an opportunity which I think can work for the next ten years or so. We have a number of exposure in in the Indian banking space and it’s an area that we really like on the long side of things. Next slide, please.

This slide is an example of where we can go down the market-cap spectrum. So, I talked earlier about the fantastic research resource that the strategy has. So, in the metals and mining side of things we’ve done a lot of work. So the metals and mining team will work closely with automotive analyst, forecasting their outlook for EV penetration and what that means for metal demand. So, they’ll work in coming up with supply demand models for all of the core commodities that go into your typical electric vehicle. This chart here just shows the kilogram per vehicle of metals of an electric car versus a conventional car. If we take copper as an example, we think that this increase in copper per vehicle, as well as the above ground charging infrastructure, all of that sort of thing, it can add about 2% per annum to the world’s copper demand. Copper has not seen any investment for the last decade.

So, the number of projects in the pipeline for copper is very limited. So that supply demand tightness will only get tighter and tighter over the years to come. There’s a number of ways to play that. So, in this strategy, we do it through some of the larger liquid companies like First Quantum, Southern Copper, Grupo Mexico. There are fantastic small-cap opportunities as well, in the metals and mining space. These companies are typically, very under researched and given the breadth of our team, we’re able to meet these companies regularly, go out and see the assets and really kick the tyres on these projects. So, a few of them named here. Adriatic Metals, Jubilee, Alphemin, Lundin Gold are all smaller mining companies that are perhaps, off the radar for many, that we like very much. There are so many mid-cap opportunities in emerging markets. That’s one of the key advantages of this strategy.

Another example of a mid-cap opportunity. I mentioned the Brazil trip that we went on last year. Many UK-based investors will be well of Ashtead Group, which is a heavy equipment rental business. There’s quite a similar company in Brazil called Armac. Brazil has, obviously, got a lot of heavy industry with the mining industry, pulp and paper, agriculture. Armac really is a rental business for this yellow line equipment. If you look at the penetration in Brazil, it’s around about 20%. If you were to compare that to the US or Japan, where you’re at 60% or 80%, there’s a long way to go in Brazil. Armac has about a 1% market share of the overall market and they are about five times as big as the number two player. So, they’re in a dominant position in an industry that can grow multiple times. They have a competitive advantage in that they insource all their maintenance, whereas their competitors will go to the dealerships for that sort of thing.

So, it can earn much higher ROEs [returns on equity] than its competitors and at the same time, charge lower prices to the customer. So, I think this sort of business really sums up the sort of thing that we’re looking for. It’s a fantastic business which can grow for many, many years to come and the valuation is very undemanding. So, this is the sort of mid-cap opportunity that we’re looking to take advantage from in this strategy. Move on to the next slide, please.

Lojas Americanas ‘short’

Then the shorting. As I mentioned there are a couple of different buckets. The first being idiosyncratic shorts. So Lojas Americanas is a business that we were short over the last year or so. It actually turned out to be the biggest corporate fraud in Brazilian history. So, it ended up effectively falling more than 95% year-to-date and that is a business we were short. We identified a number of red flags around the business. First and foremost, for any short position, fundamental outlook has to be negative. So, this was a business that was losing out to its competitors, the likes of Mercado Libre and Amazon. So, it was really struggling fundamentally. Then there were a lot of red flags around their balance sheet and cashflow was very poor. It turned out they were hiding a lot of debt off balance sheet and that came to light earlier this year. So that’s what we’re looking to do, identify this sort of company to short on the idiosyncratic side of things.

The other bucket is pair trades. So, in South Africa, we own a company called ShopRite which is a food retailer in South Africa. It’s a fantastic business, fantastic management team. They’ve been very successful in building an online platform which has been a key growth driver for them. They’ve consistently gained market share in the South African food retail market. Of course, that means there are losers in the space. Whilst we can’t disclose active short positions, here we do have a short position paired against that and this is the main market share loser in the South African food retail market. So, when ShopRite gains, this company loses. By shorting this company, we can also have a bigger position in ShopRite. So that is the way the pair trades add value to the strategy. The pair trades have been very successful historically and it’s something that we look to identify more and more of these going forward.

Russia writedown

If we go on to performance and outlook. This slide, I won’t speak on for too long. Unfortunately, it was a tough 2022 for the strategy and the reason for that, which I’m sure we’ll touch on in a bit more detail later, was the exposure to Russia. I think the Russian exposure was predicated on a strong backdrop for commodities and oil and gas, in particular. I think some of the companies that we were invested in, were offering extremely attractive valuations and dividend yields. Unfortunately, the war in Ukraine meant that we had to write those investments down to zero. So that was a painful experience, that Russia exposure last year. So, if we move on to the next slide.

This gives an overview of what happened in 2022. So, after the invasion took place, Russian securities were effectively suspended. We retain ownership of those securities, but given the inability to trade them, those stocks have been written to zero in the NAV of the company. The story of last year, was really a rebalancing of the portfolio in the second half of the year. So, Russia accounted for a lot of our commodities and value exposure within the strategy and that was gradually replaced through the latter half of 2022. If I were to look at the performance since 1st September, we’ve stabilised and started to see a recovery in performance, after obviously, a very painful period at the start of the year. So, the long-term track record of the FAST strategy on which FEML is based since inception it remains very strong. The shorter-term performance of both has been please as well, but there’s a lot of catching up to do after the Russia exposure.

[TWENTY MINUTES]

So, this slide really just outlines the key country positions that we had. India, as I already mentioned, with the financial exposure and we have a number of other investments in India, but that remains a core part of the strategy, given the long-term growth drivers that I’ve outlined. China, we have a lot of exposure to as well. It’s a big part of the index, of course. There really, we have a lot of internet names. A lot of companies that are exposed to those reopening trends. Also, the consumer sector, particularly consumer staples, we have a number of investments in China. Then finally, Mexico and Brazil fall into a similar bucket. They benefit from higher commodity prices. We have quite a constructive view on commodities and both of these countries benefit as exporters of those commodities.

Mexico has its own story around nearshoring, and we have investments in an airport and a cement company that benefit from those trends. Nearshoring is going to be a driver for Mexico for many years to come. Finally, on Brazil, I think it’s very important how you’re positioned in Brazil. So, whilst there are these top-down tailwinds that the country’s enjoying, there’s also a tough political environment as well and political interference in a lot of sectors. So, you have to be very cautious as to where you allocate your capital in Brazil, I think. Then finally, the key sector positions. I think we touched on most of these already. Financials, with the main position there being the Indian banks. Materials, with the most important positions there being in these electronic vehicle or electrification exposed commodities. Then consumer and IT are other key sector positions that we have. Then, final slide.

So, this slide really just summarises those key themes and what we’re looking to invest in. The first point, ensuring all balance sheets are liquid and solvent at the stock level. So that is an incredibly important part of the process. If you were to look at the average stock that we’re invested in, they’ll have a net cash balance sheet and that becomes particularly important as you see high levels of interest rates. A lot of businesses that were over-levered and perhaps, survived for longer than they should have done in a zero-interest rate environment are now seeing that impact their P&L. So, balance sheet strength is more important than ever. We have a strong value discipline within the team.

So, we’re looking actively for companies with big dividend yields and returning cash to shareholders. That is an important corporate governance angle as well, in EM. Companies need to be run for minority investors and if they’re not returning cash via buybacks and dividends, then they’re probably not being run for minorities. So that is an important part of the process. We avoid anchoring on any single macro scenario. So, we’re quite flexible in our macro assumptions. It’s an important input for emerging markets, but it’s important not to base everything you do on one specific scenario. So, we stress test all of our investments around a number of different macro-outcomes. Country diversification is becoming increasingly important given elevated geopolitical tensions globally. So, we have a very large breadth of country exposure.

Perhaps, the country bets that we’re taking today are more metered than they have been historically, given that elevated geopolitical risk. Sector exposure as well, would fall into the same bucket. We look to have stocks that are exposed to all different sectors. This is not a consumer fund. It really does look across the piece in terms of what sectors we’re willing to invest in. Finally, smaller-cap stocks have struggled disproportionately and have derated a lot more than their larger-cap peers. So that’s throwing up a lot of opportunities as well. So, we’re always hunting for these small and mid-caps that can really offer a lot of upside in the future. To summarise, I think the structural outlook for emerging markets is incredible, given those demographic trends. It’s a great time to get involved in emerging markets, given some of the cyclical tailwinds.

Particularly, from China reopening and a peak in interest rates. So, it’s a great time to get involved in emerging markets. I think FEML is a fantastic way to gain exposure to EM, given all the tools that are available to it in terms of the ability to both long and short and the enormous research that Fidelity has available to them.

Is EM risky?

GL: Thanks very, Chris. So, Chris, going back to a point I made in my introduction, do you think investing in emerging markets is riskier than investing in developed markets?

CT: I’ll answer that question firstly, by saying I think the rewards reflect those risks. So, I think the rewards of emerging markets are fantastic and you can buy companies that can grow for the next ten, 20 years. So, there are fantastic rewards on offer in EM, from that structural trend. Are there higher risks in the asset class? I would say there’s more volatility. So, EM is the manufacturer of the world. So, it’s much more exposed to swings in demand and commodity prices. So, I think you have a lot more volatility in demand. Fortunately, I think if you look at the fundamental supply demand dynamics for most of those major commodities, it’s positive. I think we’ve come from a period of a decade of underinvestment in many metals. Oil and gas. And I think that supply demand dynamics remain tight and that remains a big tailwind for emerging markets. So, whilst there’s higher volatility, I think that’s more than compensated by the higher rewards that are on offer.

BIC not BRIC?

GL: We used to talk about BRIC, but is FEML more BIC? Over half the portfolio is in Brazil, India, and China.

CT: That’s correct. We’re around about 50% of assets are invested in those regions and it remains an important part of the benchmark. Those are some of the biggest economies that are in emerging markets. I think it’s not fair to say it’s just a BIC portfolio. Really, we are looking for opportunities outside of some of those bigger locations. So, you’ll see increasing exposure to regions like Kazakhstan, Vietnam, Mexico in the strategy as well. We have a great breadth of country exposure and we’re really looking across all of these smaller regions as well. Vietnam and Mexico, in particular, will benefit from that nearshoring trend that I mentioned earlier.

How much in China?

GL: Your China exposure’s been quite dynamic. How is your thinking evolving towards the world’s second biggest economy?

CT: I think if you were to look 12 months ago, we had an underweight position in China and that was on the back of tightening regulation in, primarily, the property sector. So, you had the three red line policy in China, which was tightening credit conditions for property developers, which is obviously, an incredibly important driver for the country. So, you had a slowdown in the real estate market. You also had tightening regulation around the technology sector. So that was weighing on some of the large-cap internet stocks, the likes of Tencent, Alibaba were being hurt by that regulation on the internet space. Then finally, obviously, the Covid lockdown policies and it was very difficult to see an end in sight for a lot of these lockdowns.

Fast-forward to the National Congress, towards the beginning of Q4 last year, a lot of these issues have been resolved. I think that if I take the property sector first, those three red lines have been relaxed and all of the policy measures since then have been reflate the property market? So, I think that policy for property has changed from a tightening one, to one of reflation. I think that we’ll see a gradual recovery from a low base in the property space. Regulation around the tech sector is being relaxed and I think you’ve seen recent news around Alibaba, I think is a step in the right direction there as well. So that side of things has improved and obviously, lockdowns are coming to an end. People are getting back to work and the economies reopening so all of those negatives that we say 12 months ago, have now reversed and over the course of Q3, Q4 last year, we increased that China exposure and we’re now more neutrally positioned.

[THIRTY MINUTES]

GL: To clarify that comparison with the benchmark, which I think is MSCI Emerging Markets index. Are you under or slightly overweight that because the exposure to China has been underweight, but Hong Kong doesn’t appear to be reflected in the benchmark according the FEML’s factsheet. So, if you add that in, do you have an overweight exposure?

CT: I think if you were to add that Hong Kong exposure to China, which we typically do. The Hong Kong section is companies that are linked very closely to China, then as at the end of February, we had a small overweight in a position in China.

Alibaba breakup

GL: You mentioned Alibaba, what do you think about the news last week? This break up into six different companies? What does that say about regulatory risk in China?

CT: I think the fact that they’re able to go ahead with this shows that there’s been a relaxation towards the tech sector in terms of some of the restrictions that were placed. I think it unlocks shareholder value. More than 100% of the profits from Alibaba were driven by the core ecommerce business and then, the cloud computing side of things is currently not profitable. So, I don’t think the market was assigning much value to that business. I think by breaking up the business, you unlock a lot of that valuation discount that the stock was trading at. At the same time, the fundamental outlook for Alibaba remains difficult. The e-commerce environment in China is very fierce and Alibaba, generally, has been losing share to companies like PDD [PDD Holdings, owner of Pinduoduo and Temu platforms], which we own in the strategy. So, whilst I think that this breakup of Alibaba unlocks valuation from a valuation perspective, it doesn’t change some of the fundamental issues that Alibaba has on the competitive side of things.

Tencent through Naspers

GL: Turning to another well-known Chinese internet company, Tencent. You’ve got a very small weighting, underweight the benchmark. Are you negative or are you just finding opportunities elsewhere?

CT: We’re not negative on Tencent by any means. We very much like the business and some of those improvements in regulation, I think, apply to the gaming sector as well. So, I think you’ll see an acceleration in gaming approvals. I think if you look at what they’ve done in short format video, so a similar platform to the likes of TikTok, they’ve been incredibly successful in short format and that will drive, add revenues for the business. Then finally on the fintech side of things, I don’t think the market assigns much value to their business there. So, I think it’s a fantastic asset and we have exposure to Tencent through Naspers, which is a holding company listed in South Africa, where the moment component of the business is their stake in Tencent. Historically, they have not returned much cash to shareholders. I think that’s changed in the last 12 months. So you’re seeing an increased level of buybacks. I think that can drive a closing of their discount to NAV to their stake in Tencent.

India opportunities

GL: Leaving China behind and thinking about India, you’ve highlighted your interest in the banks in the country. What else do you like about India? Where else do you invest?

CT: I think you have to be quite cautious in India, with regards to valuation. So whilst the majority of EM countries are trading at close to ten-year lows, in terms of their relative multiples, India is one where that’s not the case. So, you have to be much more selective when it comes to valuation. We have found other opportunities in India. Isha Motors would be one example. It’s a three-wheel vehicle company that’s benefiting from premiumisation trends. So as the Indian population moves towards middle class, they’re another big beneficiary from that tailwind. They’ve been consistently gaining market share. I think the valuation is quite attractive. So that would be one example. Another would be, MakeMyTrip, which is the largest online travel agency in India. Again, I think the valuation is appealing and it’s a big beneficiary from reopening post-Covid. So that would be another structural growth stock that we own in the country.

Latin America tailwind

GL: Brazil and Mexico, you’ve talked about nearshoring in terms of Mexico, but can you say more about Latin America and why the company’s overweight Brazil and Mexico?

CT: I mentioned a bit earlier in the presentation about how proactive some of the central banks have been in emerging market countries. I think none more so than Brazil, where they’ve hiked interest rates into the teens and inflation is running mid-single digits. So you have mid to high single-digit real interest rates in Brazil. They’ve been incredibly proactive in hiking rates and that has hurt the consumer quite a lot over the last couple of years. So the interest rates environment has been very painful for the consumer, but of course, with interest rates now looking like the peak is in sight and I think we’ll start seeing rates being cut in Brazil in the next 12 months or so. So as those interest rates come down, that’ll be a big tailwind for the consumer. So, I think the economic outlook going forward remains very attractive in Brazil.

Mexico again, it’s one that has hiked interest rates very proactively. I think if you look at all countries in terms of what they did in terms of fiscal subsidies during lockdowns, Mexico was quite strict in that they didn’t extend a lot of handouts to the population. So, it’s got an extremely positive fiscal framework. A great monetary backdrop and it benefits from this nearshoring trend. Whilst we were there last week, we visited an airport in Guadalajara. We visited logistics parks and demand is absolutely booming in Mexico. There’s a number of companies that benefit directly from companies looking to move their supply chains from China to across the border in Mexico.

Kaspi in Kazakhstan

GL: I joked earlier about FEML being BIC rather than BRIC, but in fact of course, there’s plenty outside of those three big countries. You mentioned Kazakhstan, which is quite the significant overweight position. I understand it’s all in one stock, is that right?

CT: Yes. That would be a company called Kaspi, which is one of the most fantastic opportunities across emerging markets. So that represents just under 5% of the strategy today. Kaspi has transitioned from a legacy banking business into the leading consumer lending platform. The leading ecommerce platform. The leading payments platform. It’s disintermediated almost entirely, the likes of Visa and Mastercard. It’s growing extremely strongly and trading at not far of ten times earnings. So it’s a fantastic business which is close to a monopoly in all of the verticals that it operates and it’s an attractive valuation. So that’s really the kind of business that we’re looking to identify for this strategy. Something that’s a bit off the beaten path and I think the outlook for years to come for Kaspi is fantastic.

What happened in Russia?

GL: Russia. The investment company, as you said, had to write down its holdings to zero in Russian companies after the invasion of Ukraine. Can you recap your rationale for being invested in Russia?  What happened last year and what are the lessons you learnt?

CT: So, Russia was an overweight position for us, as I mentioned. That was predicated on the fact that we had quite a strong view on commodities, oil and gas and some of the metals that Russia produces. So, the macro backdrop for Russia was extremely attractive. Then the companies, as a result, were generating huge amounts of cashflow and they were returning that cash to shareholders in the form of dividends. So, the market was extremely cheap, companies were returning cash and the outlook was very favourable for the economy. So that was the original thesis around being invested in Russia. As the geopolitical tensions began to build, we were reducing our Russia exposure.

In hindsight, we should have reduced it much more quickly to zero, but all of the research that we did at the time, we spoke to all sorts of geopolitical experts and the general consensus was that a full-blown invasion was not going to take place and that was the scenario that we believed in. Unfortunately, we were wrong and we’re now unable to trade those securities. We’ve converted them into local shares and we retain ownership, but we cannot transact. So, they have been written to zero in the NAV of the company.

FEML v FAST fund

GL: In terms of the investment company’s structure, it’s a Guernsey-based fund, but listed in London. How are you taking advantage of being a closed-end fund. How’s it different from the FAST fund you mentioned?

CT: I think the main difference is that ability to take a longer-term investment horizon and invest further down the market-cap spectrum. So, liquidity is less of an issue for our investments in the company. So some of the most fantastic opportunities in EM are really these rough diamonds that sit in that mid-cap space and the structure of this company allows us to make those investments. Unlisted is something that we have the ability to do.  It’s perhaps not the most opportune time to be invested in unlisted securities, but we will assess those opportunities as and when they come available.

[FORTY MINUTES]

Have shorts worked?

GL: I have one more question to ask about the shorting strategy, but in fact, that’s been picked up by one of our viewers. So, I think we’ll go on to those questions now and do keep them coming in. just to start off with, Jim, his question is, ‘Has your enhanced investment strategy added to NAV, net asset value in the last year?’ Assume he’s talking about the shorting.

CT: Yes. So I think if you were to take that timeframe, then it hasn’t added value. I think one of the reasons for that was that we didn’t have much short exposure to Russia unfortunately. So, the individual shorting was a small drag on performance over the course of 2022. If you were to look more recently, we’ve seen a big improvement in the short performance and year-to-date, it’s been a very strong contributor to NAV. If you were to take a longer-term horizon and look at how it’s done since inception to the FAST strategy which FEML mirrors, it’s been a positive contributor for the strategy. I think if you look at the periods where the short book has performed well, it’s been in periods of high interest rates.

Predominantly, a lot of the companies that we have in the short book will be over levered. They’ll have broken balance sheets. Lower quality businesses. So when interest rates are higher, like we see today, these companies will see their cost of interest increase and a number of bankruptcies and corporate distress increases as well.

GL: It’s a neat idea this pair approach you have, of going long on a stock you like and then going short, betting a share price will fall on a company you don’t, that could be a victim of the other one’s success. Does it add to the complexity of what you’re going and how do you manage the risk?  If your long doesn’t go up and your short does go up as well, there’s two things that could go in different directions, rather than just the one.

CT: The way that we manage the risk is that we have incredible breadth on the short book. So, you’ll see at any one time, 50 to 70 ideas in the short book. So that means that the average position size is less then 40 bps. Having that diversity is a way of managing that risk profile.

GL: So that’s 0.4% of the assets, as opposed to a long position might be 1% or 2%.

CT: Exactly, that’s the case. Then there’s the level of research that we do and the depth of the research team. So not only do we have analysts covering all individual sectors, we also have a team of analysts that are dedicated to shorting. That was my job for a number of years. It’s this team’s job to monitor to all these positions and work out when the thesis is going well or maybe something’s changed that the thesis is no longer valid and we’ll reduce that position. It’s something that we manage extremely closely and we have a weekly meeting, Nick, I and one of the shorting analysts where we go through all of the short book and discuss what’s going on.

South-East Asia

It’s quite striking from an earlier slide about the increase in consumer spending in Asia. Mike King wanted to know a bit more about your view of Southeast Asian opportunities outside of China. He cites Vietnam which you’ve mentioned. Could you say a bit more about Vietnam and any other countries in that area?

I think after Mexico, Vietnam’s probably the biggest beneficiary from a movement in supply chains. So, it may surprise some people that labour costs in Mexico, for example, are cheaper than China. That applies to Vietnam as well. So, a lot of businesses in developed markets are shifting their supply chain to places like Vietnam. One investment that we have on the long side there, is a company called FPT, which is predominantly a consulting business based in Vietnam. They will compete with some of the US and European consultant firms. We’ve done a lot of research, speaking to their customer-base and the general view is that they offer a superior service at a fraction of the cost of some of the developed market peers. Anecdotally, I heard of one of their German customers, who does business with FPT and their Vietnamese staff all learnt German as part of the pitch for business. So, it’s a very dynamic company that’s been gaining a lot of market share and it trades at a fraction of the valuation of some of the US listed consultancies.

Bank contagion?

GL: We referred to the problems that the banking sector have been having, the concerns about those banks. Is there a risk of a credit crunch? There’s a lot of talk about the credit crunch having a spill-over effect in areas in the west. How could that effect emerging markets, if there’s a reduction in lending and credit.

CT: The risk of contagion to emerging markets is very low. If you look at the drivers to what has been causing alarm in some of the developed market banks, it’s typically the deposit side of the balance sheet. Really, the banks that we’re investing in, in emerging markets will always be deposit funded. We’re not investing in wholesale funded businesses. So they will all look generally, for the highest quality deposit franchise in each of the regions that we’re covering. These businesses are much more immune from this level of stress.

Mining and environment

GL: An area of interest, obviously, is in mining. The metal miners, finding the commodities for our electric vehicles. Your interest in firms like First Quantum, Adriatic that you mentioned, how do you manage that in terms of environmental impact?

CT: That’s an incredibly important part of what we do. So, each of our analysts, they’ll have their coverage list of all the stocks within their sector. They’ll have a fundamental rating on each of these positions where they rate it a buy or a sell, depending on whether they see it as attractively valued with a good fundamental outlook, that sort of thing. They’ll also have an ESG rating on every company that they cover and that is really industry specific. So, there’s a list of questions and criteria in each industry and they’ll do that analysis on each of the companies that they cover. So, we’re doing the checks that a mining company, for example is not polluting tis local rivers or putting out too many emissions. It’s really a forward-looking process as well.

So, we’ll engage with the companies. We’ll have meetings with them that are dedicated to ESG, where we talk about their targets for the next five, ten years. That sort of thing. We have a dedicated ESG team that helps the analysts out with this. So it’s an incredibly important part of what we do, but it always has been and we’ve always done this work around ESG and it’s incredibly important, particularly in emerging markets. Especially on the governance side of things, where you don’t have some of the institutional framework that you have in developed markets. So working out whether minority investors are being treated fairly from a governance perspective is an incredibly important part of the process.

What about North Africa?

GL: Going back to a geographical interest. Got a question here from Charles Mitchel. He’s asking, ‘Do you have exposure to North Africa?’

CT: We don’t have material exposure to North Africa. If you were to look at most of the African exposure that we have in the strategy, it would come from South Africa. The exceptions there would be in the commodities space, where a lot of the mines are located in Central Africa. So North Africa is not a big component of the emerging market index and it’s not a big part of our exposure either. If you were to take a country like Egypt, for example, it’s got incredible demographic trends as we’ve outlined earlier. Rising working age population, but we have more concerns about the sustainability of the economic imbalances in the country. So, it’s actually one that we’ve avoided.

GL: That would be classified as a frontier market.

CT: It would, yes.

GL: You do invest in those as well as mainstream emerging?

CT: Yes, we do. The core holdings are mainly in emerging markets. Some, for example, like Vietnam would be defined by MSCI as frontier, but we see I think, a clear path for Vietnam, to be promoted to emerging markets, definitely within the next five years.

GL: That can have a very positive effect because more tracker funds, if nothing else, pile in.

CT: Yes, particularly from a liquidity perspective, it can have positive impacts, yes.

UK emerging market plays

GL: Going back to the mining companies you mentioned earlier, was it Adriatic Metals, is that a UK listed?

CT: Yes, it’s a UK company. It has listings in London and Australia. We’ve been a shareholder for quite a long period of time. Fidelity is one of the larger shareholders of the business. The mine is located in Bosnia. I think it’s one of the most fantastic projects across the world in mining. If you look at the payback period for their capex that they’ve invested, is probably less than a year. It’s a zinc, silver, polymetallic asset. I think what they’re doing on the social CSR side of things is fantastic as well, in terms of them reaching out to local communities. So yes, I have an incredibly positive view on the management team, which in the metals and mining sector is very important. Also, on the asset as well. That mine should be coming into production in the new future.

[FIFTY MINUTES]

GL: Is that a big theme or weighting within the portfolio, of having UK-listed or companies that are outside of emerging market stock exchanges, but are operating in emerging markets?

CT: I wouldn’t say it’s massive, but it is a material part of the assets. First Quantum would be another example. It’s a Canadian listed business, but the core assets are in Africa and Panama. So when a company has all of their operations in emerging markets, but the listing is on a developed market exchange, then we would typically classify that as an EM stock.

GL: You’re clearly interested in the opportunity in the mid-caps after their falls last year. How much of FEML is invested in larger and medium and small?

CT: It depends exactly how you define small and mic-cap, but if you were to think of that chart where you had the 100 allocation and the 30 extension. Roughly that 30 extension will typically be in those smaller mid-caps and small-caps. So, I think it’s fair to say, about 30% of the NAV would be invested in those sorts of opportunities.

Could China do a Russia?

GL: Jim has become back with another question. Back to China, Chris. Jim asks, ‘Do you worry about China becoming the next Russia?’

CT: It’s a very important thing to monitor and yes, we’ve definitely increased the number of calls to former MI5 agents and geopolitical experts, politicians. So we’re conducting this due diligence all the time, to try and workout what China’s strategy is. I think it’s an incredibly important question. I don’t think there’s any risks imminently of it heading in the direction of Russia, but it’s definitely something that we’re monitoring incredibly closely.

FEML shares on a discount

GL: All of this, FEML, this investment company is available for a 15% discount. The shares are trading around 15% below asset value. So that’s presumably a gap you’d like to close. You like emerging markets, you like FEML, but you can buy it at a 15% discount. How big a bargain is that?

CT: I think it’s an incredible opportunity. We were talking earlier, I put 100% of my daughter’s junior ISA into the trust. I think it’s a fantastic time to get into the asset class and I think the investment company at this level of discount is a fantastic opportunity. The strategy has been running since 2011 in the FAST fund. The long-term track record of the strategy has been very strong and I’m confident that we can deliver that. The proof will be in the pudding and if we are to deliver, then I think that discount will close over time.

GL: We can’t talk about a discount without talking about a discount control policy. Typically, it’s a board decision rather than the fund manager one, but what is the policy in terms of trying to narrow that discount with share buybacks, for example?

CT: I think that’s not something that the portfolio management team is actively involved in. To be honest, that’s a question more for the board. I think 10% was the level that we hope to project and yes, I would hope to see the discount close to below those levels, but the investment team is not involved in controlling that.

Post-Putin Russia

GL: It’s intriguing, you’ve still got those holdings in Russia, they can’t be traded. Therefore, there’s no value in them. One day, do you see a day maybe when Putin’s not in charge that Russia is brought back into the fold, those securities can be traded and then they will have a value.

CT: It’s difficult to speculate on what the future will be. It’s very difficult to see light at the end of the tunnel today, but the war won’t last forever and it’s difficult to say what the future holds for Russia when finally, the war does end or when Putin does leave. It depends a lot on the regime that eventually replaces him. So, I think it’s too early to speculate on that kind of things, realising value from those positions. What is important to emphasise is that we retain legal ownership. Those positions are held in escrow accounts. We accrue dividends into escrow accounts from those companies. They continue to operate. Typically, we were invested in exporting companies with Russia, but unfortunately, we can’t trade those securities. So, for that reason, they have to be carried at zero.

GL: In the meantime, you’ve obviously got plenty of other things to be doing in the world of emerging markets. Chris, thanks very much for you time. That’s all we’ve got time for today, but look out for more of our investment trust programmes.