Escalating tensions in the Middle East have failed to deter Fidelity Emerging Markets (FEML ), which is looking to increase its exposure through smaller companies in the region.

Chris Tennant, who co-manages the £528m investment trust with Nick Price, said the duo are ‘always looking for ideas in the Middle East’ but have been underweight as countries in the region have only recently been added to the MSCI Emerging Markets index, with Saudi Arabia being included in 2019.

‘Companies have been expensive, especially as they have not been in the benchmark for long,’ said Tennant.

However, he is finding some interesting opportunities including Saudi Arabian water and power utility group Alkhorayef, which was added to the portfolio thanks to its ‘huge investment programme in the wider infrastructure’. 

The company has 25% of market share in the country and is part of a programme to provide water in Riyadh, which Tennant said it will benefit from.

Currently, the fund has 3% invested in Saudi Arabia, 1.1% in Kuwait, and 0.5% in the United Arab Emirates.

The manager is more excited about opportunities in smaller companies, particularly those in the ulitity and consumer goods sectors. He noted these are less liquid companies, which only a couple of analysts cover, but the ‘beauty of an investment trust is that we are able to go down into that market space’.

Tennant added that these companies, which would not be found in the his similarly invested £199m Fidelity Fast Emerging Markets fund, are ‘growing quickly and the long-term outlook is fantastic’. 

The fund manager noted ‘communications and access’ to company boards in the Middle East is ‘not as great as other markets’ which makes it difficult for manager to get to know, and ultimately invest in, businesses.

However, Tennant and Price have made inroads in this problem, visiting the Middle East this year along with the trust’s board directors.

Another issue with Middle East investing is ‘a big chunk of the market is financials and petro-chem’, and Tennant and Price ‘do not like either of those’.

The duo avoids financials as Middle Eastern monetary policy is ‘tied to the US’ and current interest rates have made an ‘extremely competitive market for deposits’, impacting banks’ net interest margins – the difference between the amount of money a bank is earning as interest on loans versus the amount of interest it is paying on deposits.

For petro-chem shares, Tennant said the ‘supply-demand dynamics are not attractive’.

Macro-economic outlook

More generally, Tennant is positive about the investment environment in Saudi Arabia, where he said the ‘demographics are fantastic’ and there is ‘an improving social balance’ albeit from a ‘low base’, with more women being brought into the workplace.

‘The direction of travel is positive,’ he said.

However, Tennant said the escalating tensions in the region amid the Israel-Hamas conflict that has drawn in Iran and the US are ‘worrying’.

‘We are doing some calls with political experts in the region and trying to establish the implications for different countries and a range of likely outcomes,’ he said.

The managers also called on political experts to help them navigate the outbreak of war in Ukraine. Price admitted last year that he ‘underestimated’ the fallout from the Russian invasion of Ukraine. The fund had a high exposure to Russia and was then forced to write many of those holdings down to zero.

The portfolio was doubly hit as the underweight to the Middle East saw the managers miss out on the rally that followed the Ukraine invasion.

This knocked the fund, which has underperformed the MSCI Emerging Markets index over three, five and 10 years, although over the past year it has inched ahead with a net asset value total return of 3.1% versus a 2.4% rise in the index.