Fidelity Emerging Markets (FEML ) is looking to gradually correct an underweight to Saudi Arabia but is proceeding cautiously following the outbreak of war between Israel and Hamas. 

Chris Tennant, who has co-managed the £528m investment trust with Nick Price for two years after Fidelity won the mandate from Genesis Investment Management, said they were ‘always looking for ideas in the Middle East’. The fund has been below the benchmark weighting since countries in the region were added to the MSCI Emerging Markets index in the past 10 years, with Saudi Arabia admitted in 2019.

One company they added last year is Alkhorayef, an $846m (£696m) Saudi Arabian water and power utility group that was attractive due 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, below the 4.2% benchmark weighting, but 1.1% in Kuwait which is slightly more than the 0.9% in the MSCI index, and 0.5% in the United Arab Emirates below the 1.4% MSCI allocation.

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 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 managers 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 fund managers avoid 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.

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

‘Worrying’ conflict

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 resulting from the Israel-Hamas conflict were ‘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 investment trust 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 invests 20% in India, 14% in China below a benchmark weight of nearly 30%, and 9.6% in Brazil compared to 5.4% in the MSCI index. Net asset value has fallen 19.7% in the past three years compared to a 6.5% decline in the MSCI Emerging Markets index, although over the past year NAV has gained by 4.2% in line with the index. The shares stand on a 16% discount to NAV, wider than the 12% average of its peer group. They have gained 6% in the past 12 months but have shed nearly a quarter over three years.