After strong rises earlier this year shares in companies traded on the Chinese mainland, known as A shares, have experienced sharp falls. Despite some extreme measures by the Chinese authorities, including the suspension of trading in more than 1,000 companies, the turbulence is continuing: earlier this week the Shanghai Composite Index experienced an 8.5 per cent fall in one day. While this might seem alarming or off-putting for investors, Dale Nicholls, manager of Fidelity China Special Situations (FCSS) investment trust, is topping up on his favourite holdings.
"The valuations are clearly much more attractive when you look across all the Chinese markets - not just the A shares - but also the H (Hong Kong) shares, the primary area I am invested in," says Mr Nicholls. "There have been some pretty significant declines in some of the holdings and that volatility has provided good opportunities to add to some names - particularly the more illiquid ones."
Although the market may not have hit the bottom Mr Nicholls is investing on the basis that over the long term stocks will follow earnings. "If I've got a company on which I am very confident over the long term and the valuation is at a reasonable level, the earnings should come through and the stock prices should follow that," he explains. "You've also got to keep in mind that this correction follows a very significant rise. Much of the A share market is retail-driven, so there will naturally be more volatility. There was also a fair bit of margin financing behind a lot of the rise and that probably went too far, so as that adjusts there have been some pretty significant declines.
"Over the mid term - and this applies to most of the markets in China - there's good opportunity. There's a fair bit of negative sentiment towards China from a macro sense but on a micro level, looking at individual companies, there are still good opportunities."
He tends to focus on the larger-caps in the A share market because that is where he finds most value. "There is more mispricing among large-caps," he says.
"In sectors such as consumer appliances and some of the utility-type sectors, where valuations are much more attractive, there were some pretty big declines, so it gave me an opportunity to add to some of those names."
These include Zhejiang Supor Company (002032:Ch) which specialises in cookware and bus business Zhengzhou Yutong Bus (600066:SHH).
But he adds that where there have been declines of 20 per cent or more in small A share companies, these too are providing good opportunities in sectors such as building materials and household furnishing.
Fidelity China Special Situations has about 22 per cent of its assets in A shares, but because of a short position its net exposure is only about 18 per cent. "I am concerned on market behaviour, so I have a short on the index as a whole, and because it is very hard to short individual A shares," says Mr Nicholls. "But with the correction I have been adding to some of the long positions."
He also has shorts on individual names in the Hong Kong market in areas that are overhyped and have high valuations, such as cement. However, he has added to some of the smaller-caps in the H share market, which has also experienced substantial declines, including Dongpeng (3386:HKG), a ceramic floor tile manufacturer, which he says has good management.
"In the Hong Kong market I focus on the China-related names so you still have that link to the mainland. The market has much more of an institutional base so doesn't suffer the same levels of volatility as you get on the A share market. It hasn't had the same run-up and hasn't declined as much as the A share markets."
Dale Nicholls CV Dale Nicholls has managed Fidelity China Special Situations since 1 April 2014. He joined Fidelity in 1996 as a research analyst covering several Japanese sectors. From 1999, he managed Japanese sector funds and in September 2003 became manager of Fidelity Funds Pacific Fund (LU1033664373). Mr Nicholls has also managed regional small-cap funds such as Fidelity Funds Asian Smaller Companies (LU0702160192), and has 20 years investment experience. |
Fidelity China Special Situations' largest sector exposure is consumer discretionary. "I think consumption is the really interesting part of the China story over the next five to 10 years," says Mr Nicholls. "You've got this natural rebalancing that the government is trying to bring about in terms of a shift away from reliance on investment and net exports to consumption. Consumer names also tend to be more stable businesses so have lagged behind in the market upswing but not necessarily fallen as hard in the decline. These companies have been more of a detractor from the trust's performance in the past 12 months, but I'm hoping that can start to turn in the next 12."
Consumer companies in the trust's top 10 holdings include China Lodging Group (HTHT:NSQ), an economy hotels chain operator.
Mr Nicholls also sees potential in the auto sector as China is the world's largest car market, but ownership is relatively low - even in the first cities only around 100 out of every 1,000 people own a car, whereas in the US it is about 700 out of every 1000. He adds that Chinese consumers are also upgrading their cars.
Portfolio holdings in this area include SAIC Motor Corporation (600104:SHH).
Watch our video interview with Mr Nicholls at www.investorschronicle.co.uk/funds-and-etfs/
