25 Mar 2022
From US ADR de-listings to geopolitics and rising Covid cases, there have been no shortage of issues for investors in China to face of late. Fidelity China Consumer Fund portfolio manager Hyomi Jie shares her latest thoughts on the market backdrop and outlines where she sees a disconnect between sentiment, valuations and fundamentals.
Chinese equities have continued to experience heightened volatility due to a number of factors. Most recently, the US Securities and Exchange Commission identified five Chinese stocks for potential delisting from US exchanges, which is a continuation and formalisation of the rhetoric of Donald Trump’s previous administration. So, this isn’t a new topic, but concerns have re-emerged around the impact on liquidity and demand.
While these stocks are fully fungible between their US and HK listing lines, a certain portion of global institutional investors won’t be able to own Hong Kong-listed names due to mandate or compliance requirements, while many foreign retail investors might not like owning Hong Kong- listed shares due to different trading time zones and complications in account management. Given this, I’m mindful that US ADR delisting could inevitably depress liquidity and dampen investor sentiment, but it is important to recognise that the impact on company fundamentals is much less pronounced.
Our China Consumer strategy has no exposure to the five names added to the Holding Foreign Companies Accountable Act (HFCAA). Regarding other US ADRs, we maintain very limited ADR exposure as majority of US ADR holdings have already been gradually converted to a Hong Kong line over the past two years. Within the portfolio’s existing ADRs holdings, all of them are dual-listed in Hong Kong, thus the potential impact to the fund is very limited even in case of US delisting.
In fact, most Chinese companies with a US listing are tech or consumer-focused, where underlying demand depends on China’s growing middle class and the health of the domestic economy. Therefore, instead of selling on the resurfaced ADR news, I’ve maintained high conviction in companies like Moutai and Mengniu, as they have strong pricing power and the structural growth in consumers' demand for premiumisation products remain solid. Meanwhile, I’ve been adding to our position in HKEX (Hong Kong Exchanges and Clearing Limited) as I believe the company is expected to benefit from secular tailwinds relating to more companies seeking a primary listing in Hong Kong.
This tragic conflict and growing geopolitical tensions could result in disruptions in supply chains plus drive-up global inflation. While the direct impact on Chinese consumers is relatively limited and is less of a concern than those affected in Europe and the US (given China is less reliant on imported energy and food), the geopolitical spillover risks appear more challenging for the country.
This elevated risk premium reflects international investors' broader concerns over: a) potential sanction risks as China hasn’t completely distanced itself from Russia; b) financial market decoupling risks between China and the West, notably the delisting risk for ADRs.
The Chinese government’s rhetoric around the conflict is hard to gauge but what’s clear at this juncture, is that - unlike Russia’s ‘at all cost‘ narrative - China’s ambitions depend on a relatively open global economy in trade to suit its own interests. China has been the largest exporter in the world since 2009 so I think it has little to gain and probably much to lose by being Russia’s ally.
China’s recent ‘Two Sessions’ meeting also reiterated policymakers’ intention to put economic stability and growth back to the top of agenda; once again their policy stance was clear that 2022 would be a year of growth revival. With this in mind, I expect liquidity to improve as various stimulus measures are announced - such as tax rebates, mortgage relaxation, and commitment to domestic consumption expansion.
Rising Covid cases and sporadic lockdowns of big cities like Shanghai and Shenzhen can curtail consumption behaviour thus delaying China’s macro recovery. With respect to production and potential supply chain concerns, although Shenzhen is where many company headquarters are based, it’s not necessarily where they manufacture as it is a very expensive city and not ideal for cheap manufacturing. While companies with Shenzhen operations will see production halts, it’s not peak season for many technology products, therefore, I expect a limited impact - unless, of course, we see a prolonged lockdown.
Amid global market uncertainty and a general risk-off environment, the volatility of the markets is taking a toll on equities, with growth areas being sold off the most. This has, in turn, impacted consumer discretionary and communication services companies with ample liquidity. Also, value areas of the market, such as banks and commodities related stocks have outperformed amid the current market narrative. As per the remit of the portfolio, these are not areas we typically invest in, thus the underweight exposure to those sectors detracted from relative returns.
While I acknowledge that the demand for defensives and low-beta equities is high during a period with uncertainties, some value opportunities are fundamentally expensive when their growth potential is taken into consideration. Therefore, it’s vital to understand that against a market backdrop where price actions are heavily influenced by sentiment swings and risk aversion, it provides us a guide to assess risk/reward opportunities as we see a disconnect between fundamental and valuations.
As such, I continue to emphasise growth opportunities, especially those high-quality growth names with strong fundamentals but have seen significant de-rating in the recent sell-off. Furthermore, I still believe that the consumption theme remains a key driver of Chinese GDP and will deliver stronger growth versus the broader market.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of an investment in overseas markets. Investments in emerging markets can also be more volatile than other more developed markets. The Fidelity China Consumer Fund has the potential of having high volatility either due to its composition or portfolio management techniques. It 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. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.