26 Nov 2021
Fidelity Asia Pacific Opportunities portfolio manager Anthony Srom explains why caution and selectivity will be key for 2022. He gives his investment outlook for the region and outlines the pockets of the market which he believes offer attractive upside potential for discerning stock pickers.
The market is relatively expensive with a high degree of risk, be that macro or political. The regional benchmark has fallen quite significantly from its peak, despite massive monetary and fiscal stimulus plus economies gradually ‘re-opening’. It’s difficult to predict future returns, but our expectation is for low single digit total returns on an annualised basis over the medium-term. That said, we’ll wait for opportunities to emerge and remain of the view that careful and focused stock picking is the primary way to generate alpha.
The prospect of a devaluation of the renminbi is the biggest ‘X factor’ in my mind. It’s something the market is not focused on and over the short-term, would be taken negatively. In China, GDP growth has been slowing for years. The deleveraging campaign didn’t really de-lever the economy. It just results in leverage rising at a slower rate. At the same time, FX reserves haven’t been growing strongly, which constrains money creation and therefore economic growth. It’s a question of how much more pain the government can take and I suspect it’s not much more.
In terms of portfolio exposure, we’re looking at whether companies are domestically exposed or more internationally exposed. Chinese exporters would benefit from a devaluation. It is also relevant to understand if they have US dollar debt or local currency debt.
Given our cautious market view, the primary way to generate performance is through careful stock picking and there are opportunities. Select China A-shares continue to offer good risk/reward and large sentiment swings can present mis-priced opportunities.
Regulation in China is a hot topic for investors. The positive news is that regulation is being increasingly ‘factored’ in by the market and valuations have started to reflect this and, in some cases, over-corrected. For example, the fund has used negative sentiment towards the property sector and linked industries to buy Chinese paint company SKSHU Paint. The stock price was down significantly, but we have taken a view that even if new development of buildings does slow down, the demand for paint remains robust due to renovation and maintenance needs. Plus, the industry structure is favourable.
There are opportunities to benefit from dips in the semiconductor cycle. The long-term structural drivers of technology are material and unlikely to dissipate in the near-term. Key beneficiaries of this include leading Asian companies like TSMC, SK Hynix and Mediatek. Money making opportunities are likely to present themselves when market sentiment turns negative based on a short-term view of inventory or demand.
The market is focused on how transitory this bout of higher inflation will be. We believe that inflation is likely to be higher for longer and continue to focus on stock selection. Companies with genuine pricing power and capex light business models are preferred.
We have relatively high conviction in some of the leading global technology firms based in Asia. The portfolio is exposed to the hardware value chain through equipment supply, foundry and memory, where there is a clear structural supply/demand gap. It is important to look at both cyclical and structural factors in these industries and it looks like we are in a shallow cyclical downturn. Stock prices have reacted quite severely, particularly in the memory space. The negative sentiment has depressed stock prices in the short-term; however, the long-term opportunity hasn’t changed. Structural demand for servers, artificial intelligence and machine learning is still intact.
Sustainability is becoming a greater focus for the market overall and we consider this within the holistic fundamental analysis of a business. ESG is both a risk factor to consider, but also an opportunity given it involves regulatory change and policy support. However, we are also aware that this is a trend with lots of positive sentiment behind it, thus valuations may be rich for certain companies linked to ESG themes.
Waterproofing and insulation materials company Beijing Oriental Yuhong is an example of integration of sustainability consideration into the investment process. While the industry environment is favourable for the company as government regulation is getting tighter on waterproofing quality, the company’s insulation business also stands to benefit from the Chinese government’s carbon neutral commitment by 2060. Properties are among the largest carbon emitters, so good insulation will go a long way to cutting emissions.
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. Investments in small or emerging markets may be more volatile than other more developed markets. Changes in currency exchange rates may affect the value of investments in overseas markets. The Fidelity Asia Pacific Opportunities Fund invests in a relatively small number of companies and so may carry more risk than funds that are more diversified. It can also use financial derivative instruments for investment purposes, which may expose the fund 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.