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Fidelity® Strategic Disciplines

Fourth Quarter 2023 Review

Fidelity® Tax-Managed International Equity Index Strategy
BY RICHARD BYRNE, PORTFOLIO MANAGER, STRATEGIC ADVISERS – January 24, 2024

Investment Objective

  • The Fidelity® Tax-Managed International Equity Index Strategy seeks long-term growth potential of international developed-market stocks as well as to deliver enhanced after-tax returns through active tax management.


Key Takeaways

  • Market Backdrop: International developed stocks delivered healthy gains for both the quarter and the year.1 Investors appeared less concerned about inflation or the risks of deep recessions.
  • Performance: The strategy witnessed positive returns for the quarter and the year (pre-tax, net of fees).
  • Tax Management: The strategy delivered enhanced returns on an after-tax basis for the quarter and the year (net of fees).
  • Outlook: Easing inflation may continue to help consumer spending and global economies, but recession concerns linger.



Market Backdrop

Global economies felt a boost from improved investor sentiment as central banks indicated they may be reaching an end to interest rate hikes.

  • European and Japanese stocks were the top performers for the quarter and the year.2
  • Despite optimism for China’s re-opening earlier this year, a full economic recovery did not materialize.

Throughout the year, central banks across most regions raised interest rates to combat inflation. Inflation declined but remained high as the year ended.3 Rate hikes generally take 12 to 18 months to take effect. As a result, investors anticipate inflation to further ease in the coming year. Historically, stocks and bonds perform well in the year following the end of interest rate hikes.

High levels of local government debt and an overdeveloped real estate market led to uneven growth in China. This unevenness weighed on global market economies with strong trading partnerships with China. For example, Europe’s materials sector likely faltered in reaction to China’s slowing demand for commodities. Should developments in China improve, it could bolster the outlook for many other economies.

Resilient earnings growth in 2023 drove Europe’s strong performance. Additionally, Europe’s earnings growth outlook for 2024 improved, despite the conflict in Ukraine. Even though European manufacturing lagged, some sectors prospered. Europe’s top performing sector for the year was information technology,4 which benefited from recent interest in developing artificial intelligence technology. In Japan, corporate governance reforms helped corporate profits. Japan also had lower interest rates relative to the rest of the world.



Strategy Performance

The strategy performed in line with the Fidelity Developed International ex. North America Focus Index for the quarter but lagged for the year (pre-tax, net-of-fee).

  • International developed stocks witnessed positive returns5 for the quarter and the year as central banks signaled an end to interest rate increases if inflation continues to ease.
  • Quality stocks6 outperformed both growth and value stocks for the quarter and the year.7

The decline in interest rates supported growth stocks, which outperformed value stocks for the year.8 Lower rates can justify higher valuation metrics for businesses with above average revenue growth that have yet to generate high profits.

At the sector level, information technology and industrial stocks were the best performers in the year. Enthusiasm for emerging technologies elevated information technology stock returns. Meanwhile, industrial stocks likely benefited from an emerging trend of countries repatriating their manufacturing activities. Transitioning manufacturing operations onshore requires significant investment in constructing physical infrastructure. This supports demand for industrial building materials like cement and steel.

We invest with a long-term view and continue to rebalance portfolios in an effort to keep pace with the index on a pre-tax basis. It is important to note that when including fees, the strategy will generally lag the index on a pre-tax basis.



Active Tax Management*

The strategy delivered enhanced returns on an after-tax basis (net of fees) for the quarter and the year.

  • Volatility declined in the fourth quarter after a turbulent year.
  • We sought to take advantage of volatility to find tax-loss harvesting opportunities using our active tax management techniques.

Throughout the year, we looked for ways to reduce the impact of taxes on your account. Even with the positive returns for the quarter, there were some opportunities to tax-loss harvest within the health care, industrial, and consumer staples sectors. While working to reduce taxes is an important part of what we do, our priority is to maintain the right risk profile for your portfolio.



Outlook

Inflation will continue to be a key influence for central banks and the overall direction of interest rates.

  • We’ve yet to see a full-blown recession hit any of the major economies, but there have been sectors that have displayed recessionary traits.
  • China’s economy and financial condition remain important considerations for economies that generate significant revenues via trade.

Despite easing inflation and strong market returns, we believe we will eventually see a recession in the U.S. and several developed markets. Some international developed sectors have shown recessionary traits such as low manufacturing levels11 and declining consumer confidence.12 Most economies across the globe have been moving through late-cycle expansions and recessions have historically tended to directly follow such periods.

The ongoing conflicts and humanitarian crises in Ukraine and the Middle East will be key areas of focus for investors. These areas have had limited impact on economic and market conditions so far, but that could change in the future.

A new era of growth may be in store for international developed markets. Continued trade tensions between the U.S. and China are prompting many nations to redirect capital investments. Trends such as de-globalization, onshoring of manufacturing, and energy improvements will require significant infrastructure spending. These investments are likely to support economies and stock markets around the world for years to come.

Investing in international stocks may also provide another advantage. Roughly 40% of the stocks within the MSCI All Country World Index are domiciled outside of the U.S. Therefore, choosing to ignore non-U.S. stocks is a big bet against diversification.

We can see from the table above that investing in international stocks can provide a diversification benefit that helps to reduce overall portfolio risk. Over time, a portfolio with a 30% allocation to international stocks has produced returns in line with U.S. stocks, but at a lower level of risk.13



The foregoing commentary was prepared by Strategic Advisers LLC based on information obtained from sources believed to be reliable but not guaranteed. Fidelity Personal and Workplace Advisers LLC (FPWA) has engaged Strategic Advisers LLC, its affiliate, to provide discretionary portfolio management services for Fidelity® International Equity Strategy accounts, subject to FPWA’s oversight. 

Strategic Advisers LLC is a registered investment adviser and a Fidelity Investments company.