11 Jun 2024
Chinese equities have recently been marked by elevated volatility, but there are signs of economic stabilisation and green shoots of improving investor sentiment. Having recently completed 10 years at the helm of Fidelity China Special Situations PLC, Dale Nicholls reflects on the key changes he’s seen on the ground through a tumultuous period and outlines why now could be an opportune time to revisit the case for Asia’s largest economy and stock market.
Key points
Since its launch in 2010, Fidelity China Special Situations PLC has offered direct exposure to China’s growth story. Our main focus has been on identifying and investing in companies that are best placed to to capitalise on China's transformation.
The inherent challenge of investing in China is how much sentiment can swing in this market - and how short-term focused it can be. In fact, sentiment in the last few years is probably the lowest I have witnessed in over 20 years of being a portfolio manager in the region, weighed down by concerns of a slower-than-expected economic recovery, regulatory pressures and ongoing geopolitical friction with the US.
However, the good news is that there are now signs of stabilisation. While valuations are still noticeably discounted, we are seeing green shoots of improved sentiment - supported by upbeat domestic consumption during the Lunar New Year and, more recently, the three-day break in early April, positive corporate earnings and better-than-expected first quarter GDP figures. The property sector remains a drag, but we believe recently announced policy measures should provide some support to this beleaguered area of the market.
My past 10 years managing the trust have underlined how important it is for us to have local expertise on-the-ground. Even when overseas market participants were most bearish during this period, we were still finding investment opportunities and were able to capitalise on the input from our locally-based China analysts to make decisions based on fundamentals.
Markets are influenced by factors such as geopolitics, which in many cases bear little influence on a company’s earnings outlook. What is also often not appreciated is the level of change that is apparent on the ground, with winners emerging and innovation flourishing across sectors, reflecting companies’ commitment to building a competitive edge.
This volatility “challenge” is also the opportunity - we’re now finding many great companies trading at attractive valuations. As long as our earnings forecasts are accurate, we believe share prices will reflect those opportunities in the long-term.
Many companies will continue to benefit from China’s long-term shift from export and investment-led growth towards higher-quality growth driven by consumption. Ongoing urbanisation and a growing middle class are well-known, but remain important drivers which underpin strengthening consumer purchasing power. This offers a range of notable structural growth potential across under-penetrated products and services.
We see trends like experience-based spending, health consciousness and premiumisation creating significant investment opportunities. There is also an increasing preference among Chinese consumers and corporates for Chinese brands and local suppliers, resulting in domestic companies taking ever greater market share in what remains one of the world’s largest markets.
For instance, Hisense Home Appliances Group is a company that has executed well in the mass-market segment, growing its market share and margins in 2023 and so far in 2024. While the ‘white collar’ area of the consumer market has had a tougher time, the lower end has been much more resilient, supported by government stimulus in the case of home appliances. It had also been trading at a very cheap valuation. The market began to recognise the value on offer with the share price performing strongly over the past year. Another example is JNBY, a designer fashion brand offering a good value proposition for its niche higher-end customers, and has been posting resilient sales numbers, despite economic headwinds. Its loyal and sophisticated customer base with high fashion awareness helps mitigate macro risks.
We are also continuing to find companies offering compelling long-term growth prospects within the industrials sector, driven by factors such as ongoing industry consolidation and continued rapid innovation. China’s share of global patent applications is approaching 50% and companies are investing ever more into research and development (R&D), particularly in areas like robotics and the related supply chain. Over time, this should feed through to improved competitiveness, better pricing power and higher returns on capital.
In emerging sectors such as electric vehicles (EVs) and renewable energy, we are also finding opportunities among enablers in the EV value chain, particularly those providing key components and services, such as EV battery manufacturers or auto parts suppliers. For example, Shenzhen Inovance Tech, a key manufacturer of industrial automation and EV power supply components, offers attractive secular growth potential. Its significant investment in R&D is bearing fruit, reflecting a strong record of market share gain both domestically and internationally. Moreover, the company benefits from strong management and excellent execution track record.
Healthcare also presents opportunities, especially in areas with low penetration like certain medical devices. Chinese companies also now have the third-largest number of innovative drugs in development globally, and are fast catching up with Europe, which currently lies second behind the US.
One of the key features from the recent earnings period was the focus companies had on improving shareholder returns - this was primarily seen with a rise in dividend pay-outs and buybacks in response to State Owned Enterprise (SOE) reforms and pressure from shareholders.
This improving corporate governance trend was particularly prominent in financials, where a number of SOEs increased dividend ratios, while smaller financials companies engaged in buybacks or boosted dividends. Additionally, several technology and internet companies have lifted pay-outs or buyback ratios, driving total shareholder return yield (including both dividend and buyback yields) into the double digits. For instance, Alibaba Group Holding and Tencent Holdings have been some of the most aggressive in hiking both dividends and buybacks. For many of these companies, we are seeing shares outstanding decline for the first time.
In addition to this encouraging trend towards increasing shareholder value, China also offers earnings growth opportunities that compare well to other markets. However, there will be differences across sectors and companies, which underscores the importance of bottom-up stock selection. Identifying companies with good long-term growth prospects, that are cash generative and have strong management teams, remains key to constructing a resilient portfolio that compounds growth over the long-term.
Change is the only constant when it comes to investing in China and the past 10 years have underlined how important it is for us to stay focused on company fundamentals. We operate in a volatile market with significant swings in sentiment. However, even through the tough markets of the last few years, we have had huge winners driven by great market opportunities supported by great management execution. Supporting this is the calibre of Fidelity’s Team China. Our analysts understand the DNA of companies; they have long-standing relationships with the companies they cover, and they understand the nuances of trends.
While the road will likely remain bumpy, we retain a high level of conviction in both the Chinese market and the long-term prospects of the underlying companies we hold in the portfolio.
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 investments in overseas markets. Investments in emerging markets can be more volatile than other more developed markets. Investments in smaller companies can carry a higher risk because their share prices may be more volatile than those of larger companies. Fidelity China Special Situations PLCS 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. Its shares are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trust can also gain additional exposure to the market, known as gearing, potentially increasing volatility. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.