15 Jan 2021
27/11/2020 | Hyomi Jie, Asia Pacific ex Japan
Around the world consumer behaviour patterns are shifting to online and nowhere is this bigger and more pervasive than in China. Hyomi Jie, portfolio manager of the Fidelity China Consumer Fund, discusses how the digitisation of consumption trends is creating new opportunities and outlines the key trends to watch out for in 2021.
We believe that the outlook for the Chinese economy remains strong as it has now reopened from lockdown. Small, localised Covid-19 outbreaks within the region have been handled swiftly and have not impacted overall economic momentum. This has re-emphasised the better visibility China has provided on this issue versus its global peers, and the ‘first-in first-out’ narrative has been validated by a notable resumption of economic activity.
This recovery should be supported by stronger services and external demand. The market share gain of China's exports is a key driver of GDP, given the global demand recovery. The services sector is also normalising, as key laggards – travel and leisure – are gaining momentum after restrictions were loosened in mid-July.
The pandemic has seen deeper penetration of online services in areas such as online groceries, entertainment and education. In addition, there has been an acceleration in ongoing structural trends, such as premiumisation, import substitution, the rise of local brands and innovative business models driven by technology.
Chinese consumers have been trading up across different consumer product categories for years. Moreover, as the Chinese become better educated and more affluent, their confidence in their own country’s products has increased compared to a decade or two ago, leading to a healthy preference for local brands.
Notably, Chinese companies have been quicker than foreign players to adapt to changing local tastes and requirements, for example using online sales channels such as live broadcasting. Certain considerations for customers have become more important amid the global pandemic, especially the focus on quality and after-sales service, tipping the balance further towards local brands. Local brands are taking a bigger share of the total Chinese economy, both from market share gains in physical goods and also from the growth of the service economy.
One area to monitor is geopolitical risk. I continue to believe the rising US-China tensions we have seen over recent times are here to stay and represent a new normal for investors. As expected, we have continued and will continue to see further tensions even after the US election. It is important to factor this into the assessment of individual companies and the extent to which they could be impacted by a deterioration in the relationship between the US and China. The focus on domestic China and the Chinese consumer should mitigate some of the associated risks with weaker investor sentiment.
The structural development in Chinese consumer behaviour and accelerating consolidation, led by industry winners, is where value can be added. The winners of these new business models are gaining further competitive advantages. Driven by these structural trends, there is still significant upside in the longer term. A longer-term investment horizon can be a differentiator by staying very tight in the long-term winners and value creators.
We believe that the overall consumption theme in China is still a very attractive investment theme for any investor. The China consumer space continues to offer one of the most exciting opportunities for the next decade, based on the long-term structural changes that we are seeing. At the macro level, household consumption is contributing more to Chinese GDP, as China relies less on exports and investment for its growth and more on consumer spending. The continued uncertainty around the path of deglobalisation is accelerating this process.
In terms of Chinese consumers specifically, the two key secular trends that have been underway are still in force. First of all, we will see winners of consumption upgrades with a rising middle class and the increasing urbanisation rate providing good visibility over the longer-term. The second point is that technology will continue to enable the consumption upgrade trend and create new business models. We are maximising exposure to this exciting China consumption story.
Premiumisation is one of the core theses of investment in the China consumer space. The trend has remained very resilient even during the pandemic, from small ticket items such as beer to large ticket items like automobiles. It is notable that high-end segments such as automobiles have seen the most resilient demand during the middle of the pandemic and the strongest recovery during the recovery phase. The top-end demand for automobiles has shown the strongest growth in the past couple of months.
We believe that high standards of corporate responsibility make good business sense and have the potential to protect and enhance investment returns. Consequently, our investment process takes ESG issues into account when, in our view, these issues have a material impact on either investment risk or return. Our core belief is that if governance is weak, then concerns related to a company’s environment and social impact will potentially follow. Equally, these concerns are reduced with robust governance. As a result, ESG is not an overlay, but embedded in all our fundamental analysis of any company which we consider for investment.
While we don’t screen out companies purely on the grounds of poor ESG performance, we adopt a positive engagement approach whereby we discuss these issues with the management of the companies in which we invest, or are considering investing, on behalf of our clients.
At a corporate level, many Chinese companies are making strong efforts to improve disclosure, ESG reporting, responsible sourcing monitoring etc. Alibaba issued its first Environmental, Social and Governance Report in 2018, which identified ESG issues as most critical to the sustainability of the company. There are other examples such as Li Ning and China Mengniu Diary that have shown they are open and willing to adopt change in this area.
The portfolio continues to have the largest exposure to the consumer discretionary sector. Some of the largest weight increases include, Meituan, a leading online food delivery company, Beike (KE Holdings), a leading online or offline property transaction platform; and Zhongsheng which is a luxury auto- dealer with a very strong after-sales service footprint across China.
I continue to own high-quality, online commerce and social platforms as China’s digital transformation is accelerating rather than slowing down. These platforms will benefit from improving returns on existing businesses and continue to invest in new areas.
We have recently seen the State Administration for Market Regulation (SAMR) release a draft paper seeking public opinion on antitrust guidelines against monopolistic practices in the internet industry. Overall, this is aimed at discouraging anti-competitive behaviour among internet platforms. While a change to current rules could affect the operating landscape, record 11.11 (singles day) sales in November 2020 highlighted that online e-commerce, gaming and food delivery plays a very important part in China and I don’t believe they would derail these very significant, structural shifts we see underway in China.
We are seeing the Chinese authorities places greater focus on how they regulate these areas and we continue to monitor the potential impact. I would stress that many of the stocks held in the portfolio play into the growth and development of the domestic consumer over the long-term. The rise of the middle class, its tremendous spending power, increasing aspirations and the way they consume, underpin a number of the portfolio’s investments. I believe these proposed draft rules are in-line with China pushing ahead with reforms to ensure fairness, protection of consumer interests and overall, the healthy development of the online economy.
Elsewhere, I remain underweight Chinese banks due to structural headwinds, but own leading insurance companies as they are beneficiaries of wealth creation and are good users of innovative technology across their business lines.