Despite the recent volatility seen in Chinese equities, Dale Nicholls, portfolio manager of Fidelity China Special Situations PLC (FCSS) believes China continues to offer attractive opportunities as the world’s second largest economy grew robustly over the first quarter of the year, highlighting the strength of its post-pandemic rebound.

Major driver of growth

China is recognised as being a major driver of growth and investment performance, not just in Asia, but in the wider world. The sheer size of China’s economy, its continued growth and ever-increasing global importance, mean investors increasingly consider exposure to China when building a balanced investment portfolio. 

Since its launch in 2010, Fidelity China Special Situations PLC (FCSS) has offered investors direct exposure to China’s growth story. Many of the stocks in the portfolio play into the growth and development of the domestic consumer such as the continued rise and scale of the middle class, its tremendous spending power, increasing aspirations and the way they consume. Consumption is therefore a core theme in the portfolio - supported by the natural development of the middle class, and the emergence of strong local brands. 

Within financials, insurance is an interesting segment, given the low penetration in protection-type life insurance areas and expected demand growth given higher incomes. The insurance sector could also, over time, see renewed demand from Covid-19, as people focus more on protection in areas such as health insurance. 

Other opportunities also appeared in the more cyclical parts of the market. For example, within the shipping industry, we’re in the rebalancing phase of the tanker cycle as tanker demand recovers while destocking - reducing the quantity of stock held - continues. Meanwhile, the supply side remains very tight - order books as a percentage of fleet are at historical lows. Areas such as dry bulk, essentially raw materials like coal or metals, should see an earlier recovery aided by targeted stimulus and infrastructure projects.

While China’s diverse listed universe remains the primary vehicle for investors looking to access China’s long-term growth story, there is an increasingly significant opportunity set among its vibrant and varied unlisted companies. 

FCSS has been investing in China’s unlisted companies since it was launched and has the ability to invest up to 10% in this space. For example, we were early investors in online e-commerce company Alibaba, which we had held as an unlisted holding for nearly three years before its record-breaking US$25 billion IPO in 2014. 

Strong recovery

As ‘first in and first out’, the Chinese economy has recovered to its pre-pandemic levels, growing by more than 18% in the first quarter of the year.1 This swift return to “normality” in China should mean lower risks relative to many other countries with higher uncertainty as they still struggle to get the virus under control. 

While the economic backdrop for China remains supportive of markets, we have seen increased volatility recently. This is not surprising given the strong move in markets last year. While valuations are clearly not as attractive as they were earlier in the year, they continue to trade at a significant discount to the US market despite arguably better growth prospects. 

More recently, performance has broadened out across the market - versus the more crowded trade in 2020. In general though, names have been trimmed where valuations were particularly stretched and continue to favour more attractively priced small and mid-cap stocks. While the valuation gap appears to have begun to close in recent months, there remains significantly undervalued companies in this part of the market. 

Future winners

Despite the recent volatility and the uncertain macro outlook, our focus remains unchanged. We are continuing to focus on undervalued companies which have good long-term growth prospects which we believe have been underestimated by the wider market. 

While some individual stocks have done quite well, particularly the Covid-19 beneficiaries, there are many laggards and still significant value in many parts of the market. We remain positive and overweight sectors that will grow in share in the economy over time. In many of these areas, Covid-19 has accelerated structural trends already underway in China.

With our in-depth bottom up fundamental analysis (an investment approach focused on the individual attributes of a company rather than those of a market or sector as a whole), we are well placed to identify - very early on - the many opportunities available among mis-priced small and medium stocks that offer direct exposure to China’s long-term growth story, in effect China’s disruptors of tomorrow.

1 - China’s Q1 GDP grows at record pace as recovery speeds up | Reuters

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