Putting China in perspective
Dale Nicholls - Portfolio Manager
From growth concerns to trade tensions, a number of headline-grabbing factors have come together to create a challenging environment for Chinese equity markets over recent months.
In the interview below Dale Nicholls, Portfolio Manager for Fidelity China Special Situations PLC, reflects on these moves and discusses whether the sell-off has created opportunities for discerning investors with a long-term view.
What is going on in China and what is driving this volatile period?
Dale Nicholls: "There are a few things. The economy clearly is slowing and that is borne out in the results and forecasts coming through from the companies we’re meeting. The slowdown tends to be in the more export orientated and cyclical areas of the market. The Manufacturing and Non-Manufacturing Purchasing Managers’ Indices look better, but elsewhere the data is more measured, which isn’t entirely surprising. We have seen an intensified focus on restricting credit growth and so it shouldn’t be a surprise that this flows into economic growth at some point, but as discussed in the past, the slowdown is happening for the right reasons if it is focused on limiting the growth in credit which I see as the biggest mid-term risk in China.
I must also highlight the so-called trade war. It is in the papers every day - we see the headlines, the rhetoric being ramped up, particularly from the US-side and clearly things have not moved in the direction that we would have hoped. I think from a markets perspective, the fact that there is discussion on implementing tariffs on the full amount of Chinese exports - which you would have to view as the worse-case scenario - and I think probably getting priced into markets, could be positive in the sense that it is a worse-case scenario that is starting to get factoring into the price."
The market was driven up last year by the BAT stocks (Baidu, Alibaba & Tencent) and they seem to have taken a dip with the rest of the market this year - do you think that is unjustified and do you think they are good investment opportunities?
"I do. The core holdings in the portfolio for me are Alibaba and Tencent. For Alibaba, there are concerns around the slowdown in consumption that we are seeing, but on our analysis you can buy its e-commerce business on forward price-earnings multiples in the teens, which is not justified given the growth in evidence (compared with the price today, over 40x current PE). There is really significant monetisation potential across the whole Alibaba ecosystem, which means there is a significant opportunity and they continue to execute well. So I think that looks quite attractive here.
With Tencent there are more company-specific issues, such as new regulation around gaming, and it is not fully clear how the new regulations are going to play out; the market clearly doesn’t like that uncertainty. I do think that this will become clearer in the coming months and the market will appreciate that certainty. I think it is very likely that there will be a stricter regime around the approval of games and how the games are operated but I still think that the underlying demand is there. It is still a good growth opportunity and it is pretty clear that the strong players will come out stronger on the other side when this regulation comes into play. So I don’t think the story there is derailed in any way and obviously the real opportunity with Tencent is the monetisation of WeChat in the mid-term and I think that story is still very much there."
Markets are down quite a bit in the last six months or so and so can you tell us what activity has occurred in the portfolio?
"As you know the portfolio is made up mostly of long positions but there are some shorts (where an investor makes money if a stock falls) and as those stocks have come down I have taken some money off the table. The valuations are now looking more reasonable for those stocks.
On the long side it is really across a range of sectors where you have seen indiscriminate selling. I would highlight the more market sensitive areas, areas like insurance, some of the security brokers, which again I think have great mid-term prospects, in fact valuations are now factoring in really no growth at all, which seems implausible. Selectively in some of the consumer names again, I think these have been oversold. In the A-share market [domestic Chinese companies listed in China] we have seen some pretty significant sell-offs, tended to be focused on more of the industrial-type names.
If you think about overall net gearing for the portfolio [additional exposure to the market through borrowing], you are starting to see it moving up to capitalise on these opportunities and I must say despite relative weak markets it is good that we have had two of the unlisted companies in the portfolio list this year - China Internet Plus (formerly 'Meituan') and Aurora Mobile. It is really positive that they were able to list this year and realise part of their potential through a listing. We continue to look at ideas - it is an ongoing process. I think there is a good chance that you will see new names enter the portfolio in the unlisted space over the next twelve months - I will leave it at that."
Credit growth - amount of credit available to a people or businesses from banking institutions.
Shorts stocks - process of borrowing shares of stocks that the portfolio manager doesn’t own and then selling shoes shares at the current market price. The goal being to buy those shares of stock at a lower price in the future (and return the borrowed shares to the lender).
Long stocks - process of owning shares in the expectation that the shares will rise in value in the future.
A-shares - also known as domestic shares. Shares that are denominated in renminbi and traded in the Shanghai/Shenzhen stock exchanges.
Gearing - the amount by which gross/net asset exposure exceeds shareholders’ funds expressed as a percentage of shareholders’ funds.
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Next AGM: July 2019
Fidelity China Special Situations PLC - Board Changes
At the recent Annual General Meeting the Board has announced the appointment of Mike Balfour as a non-executive director of the Company with effect from 1 October 2018. He will also serve as a member of the Management Engagement, Nomination and Audit Committees of the Board.
Mr Balfour has over 30 years’ experience in financial services. He was chief executive of Thomas Miller Investment Ltd until 2016 and was previously chief executive at Glasgow Investment Managers and chief investment officer at Edinburgh Fund Managers Limited. He is a non-executive director of Standard Life Investment Property Income Trust plc, Martin Currie Global Portfolio Trust plc and Perpetual Income and Growth Investment Trust plc. He also chairs the investment committee of TPT Retirement Solutions (previously The Pensions Trust) and recently retired as a non-executive director of Murray Income Trust plc. He is a member of the Institute of Chartered Accountants of Scotland.
As previously announced, John Ford has stepped down from the Board with effect from today’s date (25 July 2018). At the Annual General Meeting held earlier today, the Chairman thanked Mr Ford for his contribution to the Board.
The Chairman also announced at the recent Annual General Meeting that it has agreed that David Causer will step down from the Board at the conclusion of next year’s Annual General Meeting as he will have completed his nine year term.
Fidelity China Special Situations PLC Annual Results & new variable management fee
- Net Asset Value (NAV) returned +22.2% (total return) for year ended 31 March
- The Company increased its dividend by 40% to 3.50 pence per Ordinary Share
- New Variable Management Fee to replace existing performance fee
Fidelity China Special Situations PLC’s Net Asset Value (NAV) returned +22.2% (total return) for the year ended 31 March. The Board can also announce that the Company has increased its dividend by 40% to 3.50 pence per ordinary share. Over the tenure of portfolio manager*, Dale Nicholls, the Company’s Net Asset Value (NAV) returned +144.8%, compared to the Company’s Benchmark Index**, which returned +98.9%.
Nicholas Bull, Chairman of Fidelity China Special Situations plc, comments: “When we launched the Company back in 2010, the question we encountered was ‘why invest in China?’ Now it is, ‘what is the best way to invest in China?’ We believe that our Company, which has delivered an annualised growth rate of 12.5%*, provides investors with a highly attractive way of gaining exposure to the growing parts of the Chinese economy. The recent announcement by MSCI to include A-Shares in Company’s Benchmark is without doubt a positive step. Not only does it acknowledge the considerable development in the country’s equity markets, but it also puts China firmly on the radar for investors.”
The Board of Fidelity China Special Situations PLC has announced an overhaul to its fee structure. The Company will remove its performance fee and current fixed annual charge in favour of a new Variable Management Fee.
The model, which will take effect as of 1 July 2018, will reduce the current headline annual fee of 1.00% of net assets to 0.90% of net assets per annum. The performance fee of up to 1.00% will be removed and replaced with a variable fee which moves symmetrically +/-0.20% relative to the Company’s Benchmark Index. The maximum fee that the Company will pay is 1.10% of net assets, but if the Company underperforms against the Benchmark Index, then the overall fee could fall as low as 0.70% of net assets.
Nicholas Bull continues: “Fund fees have come under increased scrutiny in recent years as investment managers seek to prove their worth in the face of rising demand for low cost passive funds. I am pleased we can today announce a new and innovative charging structure. The new arrangement provides an overall reduction from the current management fee structure, especially in those years where the performance fee was payable.”
*Data as at 31 March 2018
** MSCI China (GBP)
China in context
1. World Economic Forum, World Population Prospects 2017, Valeriepieris
2. Visual Capitalist; Based on 2016 GDP estimates from the IMF, and 2017-2019 growth projections from the World Bank
3. IMF Database; emerging and developing Asia economies include Bangladesh, Bhutan, Brunei Darussalam, Cambodia, China, People's Republic of, FYR Macedonia, Fiji, India, Indonesia, Kiribati, Lao P.D.R., Malaysia, Maldives, Marshall Islands, Micronesia, Fed. States of, Mongolia, Myanmar, Nauru, Nepal, Palau, Papua New Guinea, Philippines, Samoa, Solomon Islands, Sri Lanka, Thailand, Timor-Leste, Tonga, Tuvalu, Vanuatu, Vietnam
4. IMF Database
5. BIS, Thomson Reuters Datastream, Fidelity International, June 2018
6. Julius Baer Wealth Report 2017, World Bank, United States Census Bureau
7. OECD Education Indicators in Focus, 2012
8, 9. Goldman Sachs, The Chinese Tourist Boom, November 2015
10. The Brookings Institution, The Unprecedented Expansion of the Global Middle Class, 2017
11. UBS/PWC Billionaires Report, 2017
12. Real Capital Analytics, June 2018
13. Jato Dynamics, for the year 2017
14. World Gold Council, for the year 2017
15. Canalys, Q3 2017
16. Federation of Swiss Watches Industry, January 2018
17. Gatesnotes, USGS, Cement Statistics, Mineral Industry of China 1990-2013
18, 19. No Ordinary Disruption: The Forces reshaping Asia, September 2015, McKinsey Global Institute
24. The World in 2050, (PPP = purchasing power parity), PWC, February 2017
Fidelity China Special Situations PLC: A-OK for China
Dale Nicholls - Portfolio Manager
The MSCI’s decision to begin including Chinese A-shares into its indices is without doubt a positive step towards the opening up of China’s capital markets. Not only does it acknowledge the considerable development in the country’s equity markets, but it also puts China firmly on the radar for investors.
We have been investing in the onshore market for some time through our QFII (Qualified Foreign Institutional Investor) quota and more recently through the Hong Kong and Shanghai/Shenzhen Stock Connect programmes. It has historically been a fertile hunting ground for stockpicking as it is under-researched yet filled with a host of compelling investment opportunities.
That said, a degree of caution and selectivity is advisable. It is important to note that the A-share market is predominantly driven by retail Chinese investors that tend to be attracted to smaller very high growth “blue sky” businesses for which valuations are often excessive.
Big or small?
Given this, I tend to find the relative valuation of larger-cap names more attractive. A prime example of a holding in this space would be Shanghai International Airport, which operates Pudong Airport in Shanghai, the second busiest airport in China. It is a beneficiary of growing Chinese domestic and international tourism. The company also has additional revenue drivers from the non-aeronautical side with a developing food, retail and beverage offering at the airport. A key advantage for Pudong Airport is it has further room to expand so it doesn’t face the capacity constraints that some of the larger more established airports face.
Elsewhere, I am also finding opportunities in the consumer space with the rise of domestic brands across a range of areas. Midea is the leading white good manufacturer in China with a diverse product offering, including air conditioning, small appliances, washing machines, and refrigerators. It is run by an independent and professional team that has high ownership of the company, aligning interests with minority shareholders. Midea has a strong focus on product mix upgrade and will launch higher-end brands as the middle class grows and Chinese consumers upgrade.
I also own Angel Yeast, China’s largest manufacturer of yeast and yeast derivative products. Constant demand from food, alcohol and drug producers means stable domestic growth and the company is also moving to expand its global footprint.
Merryn Somerset Webb on Fidelity China Special Situations PLC, MoneyWeek, March 2019
Ian Cowie on Fidelity China Special Situations PLC, The Times, March 2019
Mark Atherton on Fidelity China Special Situations PLC, The Times, February 2019