Fidelity Emerging Markets: a new lease of life?

China watchers have had plenty to digest since Ant Financial’s initial public offering (IPO) plans were dramatically pulled just over a year ago. An escalating regulatory blitz has hit big Chinese tech stocks hard in recent months, with the new environment leaving many global investors nonplussed. Even the team that runs Scottish Mortgage Investment Trust (SMT), known for its enthusiasm for Chinese mainstays such as Tencent (HK:700), recently noted that it would “continue to assess” the long-term implications of the new regulatory approach.

As is often the case in the investment trust space, such uncertainty can create bargains for brave investors. As we entered the second week of November, shares in almost all the generalist Asian and emerging market trusts traded at wider discounts to net asset value (NAV) than they had done, on average, over the previous 12 months. The options are plentiful when it comes to getting 'cheap' exposure to one of the world’s most exciting growth stories. But one trust stands out more than others, thanks to the possible gains to be made from idiosyncratic changes.

Of the eight trusts in Winterflood’s global emerging markets category, Fidelity Emerging Markets (FEML) was trading at a notably cheap level relative to its 12-month average on 8 November – a 10.1 per cent discount to NAV.

This is unsurprising in light of recent events: if investors are busy seeking to understand developments in China, they also have to digest the recent appointment of Fidelity as the trust’s new investment manager in place of Genesis.

The shift has not necessarily gone smoothly. Fidelity Emerging Markets, formerly called Genesis Emerging Markets Fund (GSS), has made the worst share price total return of all the trusts in the Association of Investment Companies Asia Pacific and Global Emerging Markets sectors between 1 July, when the management change was announced, and 8 November. And a heavily oversubscribed tender could suggest that not all shareholders are keen on the new managers. When it comes to investment trust overhauls, there have been more auspicious starts.

Embracing change

However, there are good reasons to be upbeat about this trust’s future. Firstly, some misgivings about recent events may be misplaced. When it comes to the oversubscribed tender offer, broker Stifel recently argued that this had been “misrepresented” as a sign of significant shareholder dissatisfaction with the new approach. Instead, analysts at Stifel say that any investor is likely to and should take advantage of a tender offer when they can exit at a price close to NAV. They add that almost three-quarters of shareholders who voted on the change in the investment management team backed the proposal, casting further doubt on the concept of widespread disgruntlement among shareholders. Stifel analysts instead attribute the recent widening of the discount to “shareholder indigestion” as those who don’t like the new approach make their exit.

In the context of what may be relatively short-term share price weakness, it is worth considering what the new managers at Fidelity might bring. Nick Price and Chris Tennant are running the trust along the same lines as Fidelity Active Strategy - FAST - Emerging Markets (LU0688696094), an offshore open-ended fund. This strategy should appeal in two main ways.

Firstly, the trust's managers use a mixture of long and short positions as a way of playing both “structural winners and losers” in the region. This equates to a highly active approach that may offer strong returns, especially at such a volatile moment for the region. And, importantly, this approach sets Fidelity Emerging Markets apart from the other emerging markets investment trusts which take a long-only approach. This could give its managers an edge and an extra level of appeal, supporting the share price.

Secondly, this long/short strategy has a track record of working well. The open-ended fund which is run via this approach has significantly outperformed MSCI Emerging Markets index over one, three and five years to 5 November 2021, and fared relatively well versus emerging markets investment trusts over the same periods.

Also, the trust's investment management fee has fallen significantly since Fidelity has assumed management, from 0.9 to 0.6 per cent of NAV. Fidelity has also waived its fee for the first nine months that it manages the trust. And Fidelity Emerging Markets will undertake another tender offer if its NAV returns over the five years to 30 September 2026 fail to outperform MSCI Emerging Markets index. Its board has also committed to continuation votes every five years.

A more important contribution, however, may come from the investment manager itself. Fidelity has significant resources at its disposal and can extensively market the trust. This may help to raise awareness of it, and lift the share price and narrow the discount to NAV over time.

The trust's larger shareholders include some value-minded investors and activists such as City of London Investment Management. When contacted by Investors’ Chronicle, Simon Westlake, executive at City of London Investment Management, appeared positive on the recent changes.

“We have a high regard for Fidelity’s emerging markets equity team,” he said. “Fidelity Emerging Markets has an investment management fee that is the lowest among its peers and the board has promised to offer a partial exit at close to NAV if the trust does not meet its five-year performance target. The present discount is anomalously high compared to its competitors and this represents a very attractive opportunity.”

Proof in the pudding

Fidelity Emerging Markets’ success will ultimately depend on strong performance feeding through over time. And while the newly adopted investment strategy has worked well in the past, it comes with heightened risks. Shorting can be a risky game, as can be the higher levels of long exposure granted by the use of derivatives. You may need an even higher appetite for risk and better stomach for volatility when investing in Fidelity Emerging Markets than for other emerging markets investment trusts. And if you hold this trust there is a greater need to closely monitor exactly what its managers are doing, and to understand the themes they are focusing on in both their long and short positions.

At the end of September, Fidelity Active Strategy - FAST - Emerging Markets Fund’s highest levels of short exposure, on a sector basis, were in consumer discretionary and financials stocks. On a geographical basis, its biggest short exposures were in China, although such allocations should be considered in the context of long allocations in the same area.

The recent drama in China also reminds us that emerging markets investing already comes with high risks. But with an experienced team, a good track record and a cheap entry point relative to its recent history, Fidelity Emerging Markets is an interesting opportunity for more adventurous types. Buy. DB.