Market volatility unlocks long-term value in Chinese equities

Regulatory landscape: From curbs to support

Investors may underestimate or misunderstand the somewhat cyclical nature of China's regulatory environment. We are seeing a clear increase in support for private enterprise and innovation, marking a significant shift from previous restrictive periods. One of the most visible signs of this was President Xi's recent meetings with senior executives from China's leading technology firms - a move that made headlines and reinforced the government's more constructive tone toward the tech sector and private businesses more broadly.

As part of its long-standing "self-reliance" strategy, the government continues to prioritise key areas such as domestic consumption, high-tech manufacturing, artificial intelligence, and advanced industrial automation. This focus has created a more supportive environment for companies operating in these strategic sectors.

Government policy is also playing a constructive role in improving corporate governance. We continue to see a notable rise in shareholder-focused policies, with more companies increasing dividends and initiating buybacks. This trend has already contributed to rising investment income and supported an unbroken record of growing dividends across the market. This combination of policy support and improved corporate behaviour is helping to create a more favourable environment for equity investors seeking sustainable returns.
 

Compelling valuations and sector dislocation

Chinese equity valuations remain at compelling levels, both in absolute terms and relative to other global markets. On a forward price-to-earnings basis, the MSCI China Index is trading at around 11-12x, well below historical averages and representing more than a 40% discount to the S&P 500.

Looking more closely, there is significant dispersion beneath the surface of the market. Many of the most exciting sectors, particularly consumer discretionary and healthcare, are still trading at multi-year lows despite clear structural tailwinds and earnings momentum. This creates opportunities for selective stock picking in companies with strong fundamentals that have been oversold due to broader market sentiment.

One consequence of the broader macro trends is an increasing preference among Chinese consumers and corporates for Chinese brands and local suppliers, resulting in domestic companies taking ever greater market share in what remains one of the world's largest markets. Companies such as Anta Sports Products exemplify this trend - as one of the world's largest sports equipment companies by revenue and third-largest manufacturer of sporting goods, it has seen steady market share growth from 7% in 2013 to 21% in 2023 in China. This has been achieved through its strategy to develop different brands to satisfy different client demands, enabling operational flexibility to better adapt to China's highly dynamic market while avoiding single brand risk.

In the consumer staples sector, companies like Tsingtao Brewery demonstrate the quality available at attractive valuations. With strong competitive advantages from its branding and healthy market share, it maintains pricing power and opportunities for premiumisation in a growing domestic market.

Domestic focus and quality selection

The Fidelity China Special Situations trust remains heavily invested in domestically driven sectors such as healthcare, consumer staples, and segments of industrials, which are less exposed to external shocks and more aligned with China's long-term strategic objectives. We focus on companies with strong pricing power, solid cash flows and robust balance sheets, which are better positioned to navigate periods of volatility.

Company-specific execution and fundamentals ultimately drive long-term value creation. That's why our investment process remains rooted in bottom-up research, with a strong emphasis on understanding competitive positioning, management quality, and resilience through different market environments. This focus on fundamental analysis becomes particularly valuable during periods of elevated macro uncertainty, when market sentiment can disconnect significantly from underlying business performance.

Importantly, we manage portfolio risk through active diversification across sectors, market caps, and business models, dynamically adjusting net gearing and exposures depending on the opportunity set. This approach allows us to be opportunistic when market dislocations create attractive entry points, while maintaining appropriate risk controls.

Innovation-led growth

Looking ahead, what excites us most is the opportunity to invest in outstanding companies that are executing well within growing industries, have durable competitive advantages, and remain available at attractive valuations.

Earlier this year, Chinese start-up DeepSeek's cost-effective AI model stunned the industry and highlighted China's innovative capabilities on the global stage. Beyond the recent buzz around AI, innovation is quietly thriving across all sectors and industries in China, supported by structural strengths such as deep research and development (R&D) capabilities, a strong base of talent, and abundant data. Many companies with the right products and services are increasing market penetration, maintaining or gaining competitiveness and pricing power, and growing market share both domestically and internationally.

The portfolio is well-positioned to benefit from this innovation-led growth across multiple sectors. In AI and digital infrastructure, companies like Alibaba, Kingsoft, and Tencent are expanding cloud capabilities, while platforms such as Tuhu Car and ByteDance are driving monetisation through data-led service integration. In consumer sectors, companies like Xtep International and Chicmax are harnessing strong product innovation, digital marketing, and brand segmentation to drive solid market share gains.

In the electric vehicle supply chain and autonomous driving space, Hesai is advancing next-generation mobility through intelligent sensing, while Pony.ai excels rapidly and offers lower cost robotaxis vs. its US rival Alphabet’s self-driving unit Waymo.

Healthcare and biotech research represents another area of particular strength, where China Hutchmed and Innovent Biologics serve as good examples of China's growing strength in biotech, combining advanced biologics manufacturing with innovative drug development. Meanwhile, in the industrial space, innovative industrial robot and industrial automation solutions provided by companies such as Shenzhen Inovance Technology and Weichai Power are supporting the overall industrial upgrading and improve eco-efficiency in China.

Looking beyond volatility

Collectively, these investments reflect our focus on backing innovative leaders in areas where China is steadily gaining global influence. While macroeconomic uncertainty and market volatility can be unsettling, they also create real opportunities for active investors, as stock prices often become disconnected from company fundamentals. Across many industries, companies are getting on with executing their strategies and adapting to challenges. For long-term investors, such environments often present some of the most attractive opportunities to generate excess returns.

History suggests that periods of stress and dislocation offer long-term investors some of the best opportunities to build wealth. A rise in volatility, while unsettling, can be a time of real opportunity for active investors. To this end, Chinese markets continue to offer compelling opportunities for those willing to look beyond short-term headlines in order to focus on underlying business quality and the long-term growth potential driven by a range of tailwinds.

Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments are subject to currency fluctuations. This Investment Trust invests in emerging markets which can be more volatile than other more developed markets. Fidelity China Special Situations PLC can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. This trust invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid. The shares in the investment trust are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.