It’s been a challenging start to the year for investors in China. Even prior to Covid lockdowns in key cities like Shanghai and Shenzhen and the war in Ukraine, Chinese shares were labouring under a raft of new government regulations, slowing economic growth, a dispute about auditing standards affecting Hong Kong companies with listings in New York and a global downturn in technology stocks.
More recently, there have been signs the tide may be turning. Along with world stocks, Chinese shares have rallied over the past couple of weeks, encouraged by comments from Vice Premier Liu He to the effect the government is ready to introduce market-friendly policies and boost the economy1.
Understandably, the UK’s largest China investment trust, Fidelity China Special Situations, has suffered amid the uncertainty of the past few months. It currently trades at a 7.8% discount to its net asset value compared with a discount of around 3% about this time in 20212.
The Trust’s manager Dale Nichols is finding value though. Moreover, he believes we may now have passed the peak for regulations-related news flow, given the government’s long term commitment to economic development and the associated need for a vibrant private sector.
Local governments have expedited infrastructure spending and, in sharp contrast to its global peers, China’s central bank has started to cut interest rates. Both moves should help to stabilise economic growth.
This should also help create an improving environment for the trust’s overweight holdings in consumer stocks that, in any case, are underpinned by longer term structural trends, in particular, the expansion of China’s middle class.
The trust’s overarching strategy is unchanged, in that it seeks to invest in undervalued companies that can deliver strong returns and be much bigger over time. This leads the manager to spend a good deal of his time focusing on smaller companies, which have a greater tendency to be less well researched and, therefore, more likely to be mispriced.
The trust’s largest active positions as at the end of February were in the industrials and information technology sectors – amounting to 13% and 12% of assets respectively compared with 5.9% and 6.5% for the MSCI China Index. In relation to the Index, consumer staples and real estate were the least well represented.
Most recently, Fidelity China Special Situations has closed the majority of its short positions and added to holdings in companies the manager now sees as “extremely cheap”.
Last month, China announced a growth target of about 5.5% for 2022, significantly down on the 8.1% growth rate recorded last year, but still competitive in a global context3.
Despite this, Chinese shares remain at a substantial discount to world markets. The MSCI China Index trades on less than 11 times the amount companies are expected to make over the next 12 months compared with around 17 times for world stocks4.
That supports the case for there being considerable scope for a rebound across Chinese markets beyond the rally we have seen since mid-March.
1 FT, 16.03.22
2 Fidelity International, 07.04.22
3 Reuters, 05.03.22, and National Bureau of Statistics of China, 17.01.22
4 MSCI, 31.03.22