Finding opportunities in China amid volatility

Fidelity China Special Situations PLC portfolio manager Dale Nicholls shares his outlook for 2025 and provides an insight into how he is looking to position the portfolio against an evolving macroeconomic backdrop.

What is your outlook for your asset class?

With so much focus on macroeconomic factors, it can be easy for investors to overlook what really drives superior returns are great companies executing well in growing industries where they have strong competitive advantages. While the headwinds - and indeed the tailwinds after the recent stimulus measures —are well known, I remain focused on finding opportunities amidst market volatility, where fundamental value and value creation should be recognised by the market over time. 

Despite the challenging economic environment, many companies with the right products and services are increasing market penetration, maintaining or gaining pricing power, and growing market share. However, tough conditions are widening the gap between winners and others, emphasising the importance of active management in Chinese equities. Domestic innovation is thriving, supported by strong investment in R&D, particularly across areas such as renewable energy, automation, and the electric vehicle value chain. I believe this will reinforce the trend of domestic players capturing market share from foreign competitors.

Meanwhile, recent government stimulus measures signal a strong commitment to addressing economic challenges and improving domestic demand. Though consumer confidence remains weak, our discussions with many companies suggest that the worst of the job cuts, particularly in sectors like technology, may now be behind us and elevated household savings suggest potential buying power that could support a recovery.

Until recently, earnings revisions have trended downward, but we are now seeing improvements. The hope is that supportive policies will drive a turnaround in economic fundamentals, leading to improved and broader earnings growth, which would also boost market sentiment. Against this backdrop, Chinese equities appear attractively valued compared to historical averages and other global markets, offering substantial potential for valuation multiples to expand.

Many companies are also increasingly exploring opportunities for overseas expansion. While geopolitical concerns persist, particularly around US tariffs on Chinese goods, both investors and companies are well aware of these risks. Chinese companies have been managing tariffs for some time, with many taking pre-emptive measures, such as moving production offshore. We are finding more opportunity in this area, as we see more cases where the market may be underestimating the resilience of these companies. Nonetheless, the Company is primarily focused on firms that generate most of their revenues domestically.

We also see a strong trend in companies more focused on shareholder returns, through both higher dividends and buybacks. I anticipate improving shareholder returns will continue, supported by favourable government policies but more importantly by improved governance and financial management at the companies themselves, something which I think is not fully appreciated by investors.

How are you looking to position your portfolio against this backdrop?

The Company aims to provide investors with access to a wide range of opportunities in China, leveraging the unique advantages of a closed-ended Investment Trust structure, such as the flexibility to borrow, use gearing, invest in private companies, and employ derivatives.

The consumer sectors currently offer some of the most compelling opportunities. In e-commerce, despite economic challenges, the largest platforms continue to leverage natural network effects and improved cost control, leading to strong earnings growth this year. Attractive structural growth also exists within the consumer discretionary space. Within household appliances, some of the world's largest producers are benefitting from government trade-in policies domestically and remain well-positioned for continued overseas expansion with competitive, reliable products. Similarly, sportswear is a structural growing industry, driven by increasing penetration and awareness of healthy lifestyles. Brands with a diverse and appealing value proposition, that communicate effective with Chinese consumers, remain resilient in a tough environment. Meanwhile, the staples sector, often viewed as defensive, has seen significant market volatility this year which has created mispriced opportunities in companies with strong franchises in segments such as beer and condiments.

Another key theme in China is how technology is helping to improve vital customer services. For example, in the auto service sector, which is growing due to an aging car fleet, one of the Company’s investments is using digitalisation to improve customer experience, standardise services, and increase efficiency.

More broadly, investments in areas like travel, education, consumer finance, and insurance offer strong structural growth prospects with significant potential upside when consumer sentiment improves. 

I’m also finding attractive opportunities in industrial companies, which remain the Company’s largest sector overweight compared to the Benchmark Index. Many Chinese firms have achieved scale in advanced manufacturing, supplying critical materials and components to growing industries like renewable energy, electric vehicles, and life sciences. Although the industrial automation downcycle has been prolonged, Chinese firms also continue to benefit from import substitution of higher end tools and components that have been traditionally dominated by Japanese and European companies, and exports of cheaper, high-quality products.

The healthcare is benefiting from many similar trends and is home to significant innovation too. Despite recent anti-corruption crackdowns, in the long term, increased focus on R&D over sales and promotion will further drive the development of drugs and medical devices. 

Finally, the closed-ended structure enables the Company to invest in private firms, accessing some of China’s most innovative companies in areas such as global technology platforms, autonomous driving, and biotech. 

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. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments are subject to currency fluctuations. 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. This Investment Trust invests in emerging markets which can be more volatile than other more developed markets. 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. 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.
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