Dale Nicholls (pictured right) has raised net gearing in Fidelity China Special Situations by 50 per cent since the end of February, reflecting his positive outlook on companies exposed to the “structural rise of consumption” in the world’s second-largest economy.
The manager had cut gearing from 20.89 per cent at the end of May 2017 down to 15.57 per cent in February 2018, with valuations becoming “stretched” in certain areas of the market.
However, following February’s bout of volatility, he began to raise gearing once again to fund investment in areas he felt had been unduly punished in the correction, bringing it back to 19.86 per cent by the end of May.
The figure now stands at 24 per cent, with the manager positive on the long-term investment opportunities in the market.
“The secular drivers of growing consumption, rising wealth and technological change remain as compelling as ever,” he said.
“It is this part of the economy often dubbed ‘New China’ that is driving the change in the country’s growth engine as China takes its next step of development.
“I believe this trend will grow in importance as the government attempts to reduce investment spending as a source of growth.”
The manager was also positive about the inclusion of A-shares in the MSCI Emerging Markets index, calling it a positive step towards opening China’s capital markets and saying it had put the country “firmly on the radar for investors”.
“I have had significant exposure to the A-share market for years and believe it will continue to provide a fertile hunting ground for stockpickers like me,” he added. “The market is under-researched despite a wide range of compelling opportunities.
“Despite a small-cap bias in the portfolio, of greatest interest to me at the moment are the larger cap A-shares which often seem out of favour with the standard domestic Chinese investor, who tends to be attracted by the very high-growth ‘blue-sky’ businesses for which valuations are often excessive. In general, I find the relative valuation of the larger-cap names far more attractive.”
While the manager said he has not made any major changes to the portfolio over the past year, he has increased exposure to healthcare, especially pharmaceutical distributors such as Sinopharm and China Resources Pharmaceutical. This reflects changing regulations in China which are designed to streamline distribution.
“While this has been disruptive for the market it will ultimately drive industry consolidation and it will be the strongest players with the broadest networks that will survive and ultimately come out even stronger,” he explained.
Elsewhere in the sector, he has been looking at private health through stocks such as China Resources Phoenix Healthcare, as he sees significant government appetite for shifting the financial burden away from the state.
He also increased exposure to financials, largely through life assurance providers such as China Life Insurance and China Pacific Insurance. The manager said this is because as people become wealthier, they inevitably look towards savings and insurance products to protect and increase the value of their wealth.
“China is at a very early stage in life insurance and this market offers significant growth potential,” he continued.
“The insurance sector has lagged the market due to policies limiting growth in more savings-type products. This has created buying opportunities and the shift to more protection-type products will ultimately create more value for the companies.”
The manager admitted that there are still some challenges for the Chinese market, especially with debt growth outpacing overall growth in the economy, but noted the government appears to be taking steps to tackle this situation.
He said it is essential that it continues to make progress in this area and implements reforms in sectors such as ‘shadow banking’. However, while he predicted that the impact of reform and efforts to slow credit growth will hinder economic growth, he said this is less of an issue for companies benefiting from the structural growth trends discussed above.
“In both the public and private markets, I continue to see activity with companies displaying creativity, innovation and entrepreneurship to capitalise on these shifts,” he added.
“I remain confident in the very rich opportunity the Chinese market continues to afford me as a stockpicker and continue to be personally invested in the company.”
Nicholls is less concerned about the prospects of a trade war with the US, pointing out his portfolio’s holdings are chiefly related to China’s domestic structural growth in areas such as consumption. The US accounts for just 1 per cent of its revenues.
However, he said he would be concerned if China follows through with its threat to respond with tariffs of its own.
“Ultimately this could push up input costs for Chinese companies, which will be passed on to consumers or eat into profits, neither of which is a good outcome for investors,” he added. “This is something we continue to analyse for the companies in the portfolio.”
Fidelity China Special Situations has made 158.31 per cent since Nicholls took charge in January 2014, compared with 133.77 per cent from the IT Country Specialists: Asia Pacific sector and 107.36 per cent from the MSCI China index.
Performance of fund vs sector and index over manager tenure
Source: FE Analytics
It is trading at a discount of 14.4 per cent to net asset value (NAV) compared with 12.6 and 14.64 per cent from its one and three-year averages.
The trust has ongoing charges of 1.15 per cent.