With emerging markets (EM) increasingly driven by a narrow group of stocks, flexibility matters more than ever for active managers. One way we gain greater flexibility when managing the Fidelity Emerging Markets investment trust is through short positions.
Often thought of as insurance against falling markets, shorting can actually be a meaningful generator of returns above the long book – even in rising markets. In fact, the trust’s short book has contributed ~37.5% to relative returns since Fidelity took over management of the trust in October 2021 (to 31 August 2026), despite EM equities generating strong returns over the same period.
Putting more ideas to work
A traditional long-only fund primarily acts on positive investment views. If a company is suffering from competitive pressures, deteriorating earnings or a cyclical downturn, the most you can do is avoid owning it.
We go a step further, using shorts to actively capitalise on the negative views of our portfolio management and analyst teams, aiming to profit from companies with deteriorating fundamentals and benefitting as share prices fall. And with Fidelity’s significant global analyst resource behind us, including several dedicated shorting analysts, we have a broad pool of research and ideas to draw on across the developing world.
So, how do we approach shorting? Fidelity Emerging Markets uses leverage to increase exposure to our highest-conviction long ideas, combining this with a short book that brings the net exposure back into the 95-110% range. This typically results in a gross exposure of up to 165% – meaning that for every £100 invested, you have up to £165 working for you, with more of our best ideas put to work.
What makes a good short?
Whilst our analyst ‘sell’ recommendations are often a useful input in generating short ideas, not all ‘sells’ make good shorts – something I learnt early on in my days as a shorting analyst.
Instead, we typically look for two key things when identifying companies for shorting. Firstly, the company must be in structural or cyclical decline. That could be anything from a retailer losing market share, or a manufacturer experiencing pricing pressure due to competitors adding capacity. Secondly, the company must have several additional red flags, whether that be excessive borrowing, accounting issues, weak corporate governance or regulatory concerns.
A real-world example can be seen with one of Brazil’s former largest ecommerce players. The business looked to be in structural decline, losing market share as competitive intensity rose with the likes of Shopee and Amazon entering the market. There were also several additional red flags – the company’s earnings quality deteriorated, whilst its cash generation raised questions. Eventually, significant off-balance-sheet debt came to light and the shares collapsed.
Why risk management matters
That said, shorting is not without its risks. Having spent many sleepless nights as a shorting analyst during the ‘GameStop’ era, when many short sellers suffered losses as investors piled into heavily shorted stocks and drove their share prices higher, I am ever aware of how quickly shorts can move against you. This can be particularly acute in markets with heavy retail participation.
We tackle this by placing close attention to technical factors: how crowded is the short? what is the cost of shorting? We chose to run a highly diversified short book, spreading single stock short exposure across 70-80 names. Single stock shorts are capped at 30% in aggregate, and individual positions are limited to 1% (although typically much smaller) to avoid the concentration of risk in a single name.
More than just a hedge
Shorting should not be viewed simply as insurance against falling markets. In fact, it will not necessarily protect the portfolio during every sell-off.
We saw this in March 2026, when the short book detracted from performance as a sentiment-driven sell-off hit the market’s best-loved stocks harder than the lower-quality less widely owned companies we tend to short. This is quite a different backdrop to a recessionary sell-off, where we would expect businesses with weaker balance sheets and higher leverage to be more exposed.
Instead, we see shorting quite simply: as another way to put our strongest investment views to work.
Chris Tennant is co-portfolio manager of the Fidelity Emerging Markets investment trust. The views expressed above should not be taken as investment advice.