The managers of Fidelity Emerging Markets (FEML ) are hopeful their overweight positions in Brazil and Mexico will close the gap in performance with their sector peers, as the countries receive a boost when the US Federal Reserve cuts interest rates.

Contrary to previous interest-rate-hike cycles, emerging market central banks have been very proactive, with Brazil lifting rates close to 14% by the end of last year to tackle soaring inflation. 

Inflation is now beginning to fall in Brazil and Mexico, where managers Nick Price and Chris Tennant have built respective weightings of 8.2% and 5.9%, because food is a much bigger portion of their inflation basket and food prices are coming down, Tennant (pictured below) told Citywire.

While the countries have been longstanding underweight positions in the portfolio, the pair see ‘big scope’ for their economies to benefit.

‘When rates do start to come down in the US, these countries can follow and there’s a long way to fall in somewhere like Brazil,’ he said.

‘Brazilian consumers have been under enormous pressure because they are very levered, so the high interest rate environment has had a disastrous impact on disposable income over the last 18 months.’

The overweights to Mexico, as well as a 6.5% position in Canada, is a play on the US bringing supply chains closer to home via policies such as last year’s Chips Act. One example is Mexican railway company GMXT, a 0.5% position, which has links to the US.

The £531m trust, which the pair have managed since October 2021, is some way behind its global emerging market peers after its Russian holdings were written down to zero as the West levied heavy sanctions following the outbreak of the war in Ukraine.

Other factors behind the 31% slump in shareholder returns since they took over, compared with a 9% fall for the MSCI Emerging Markets index, include having had no exposure to the beneficiaries of the war in Ukraine, such as Saudi Arabia.

Performance since taking over

Source: Morningstar

Russian holdings, which totalled 16.9% of assets in January last year according to Morningstar, constituted the bulk of the portfolio’s exposure to value stocks. These included chemicals company PhosAgro, energy group Gazprom and Sberbank. Price and Tennant had rebalanced the portfolio towards value names as global markets rotated away from growth stocks.  

They bet against the Russian index as troops amassed on the Ukraine border, which delivered a net asset value total return of 8.5% in 2022.  

Taking over the mandate from Gensis Investment Management, the pair also inherited several Nigerian holdings totalling 2% of net assets, which they have been unable to sell because of the country’s capital controls. The naira currency has since been floated, meaning they can exit the holdings that have affected returns.

The pair believe China’s reopening is more of a medium-term tailwind because its lockdown experience was ‘much more traumatic and brutally enforced, depressing consumer sentiment further, which will take longer to recover, as well as problems in the property sector’, Tennant said.

The current 18% weighting, which is 3% underweight the index is ‘a function of how badly the market’s done’, he added.

In terms of the Chinese Communist Party’s heavy-handed regulation, such as the banning of for-profit tutoring, Tennant said it was ‘much worse than anyone had predicted’.

The pair are also bullish on the outlook for commodity prices as a result of global supply chain constraints, with exposure including Brazilian heavy equipment rental company Armac.

Year to date, shares in the portfolio of long and short positions have retreated 3.2% versus the index’s 0.3% fall, to trade at a 14.9% discount, according to Numis data.

The major contributors have been technology stocks, such as the largest holding at 8.4%, chipmaker Taiwan Semiconductor Manufacturing, which shot up in line with global enablers of artificial intelligence.

The pair’s long-term record is reflected in the broadly similar open-ended Fidelity Fast Emerging Markets fund, which has fallen 0.2% over the five years to date, while the index has gained 9.3%, according to Morningstar.