116. China: the opportunities and concerns for investors in 2021

28 January 2020 (pre-recorded 26 January 2020)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Chris Salih (CS): Hello and welcome to the Investing on the go podcast. I’m Chris Salih and today we’re joined by Dale Nicholls, manager of the Elite Rated Fidelity China Special Situations Trust. Thank you for joining us today.

Dale Nicholls (DN): Thanks Chris, good to be here.

[INTERVIEW]

[0:17]

CS: I’m going to start with a bit of geopolitics. So, I guess, what does a Biden Presidency mean for China and its companies? And, and does it change anything or the direction of travel for the country?

DN: Yeah, well it’s obviously still very early days, but every indication we get that it’s going to be very much the same. So it seems in the you know, the appointment hearings with the [inaudible], et cetera, it seems like the line is very much the same and it’s going to be a relatively hard line. I think the changes you can expect at least from the US side is probably a more multilateral approach. And I think, you know, probably see an increased focus on human rights probably at the margin. You know, I think, you know, from the China perspective, one thing they’ll probably appreciate is just a little bit more predictability. And I think probably investors are in the same category there in terms of US policy, but overall, I don’t expect a huge change you know, in policy there, I think, you know, the competition and friction there is really going to be with us for decades going forward. I think, you know, from a market perspective on the positive side, I think that’s more accepted. And, and probably pretty much, pretty much consensus.

[1:33]

CS: China was part of a huge inter-regional trade deal that was signed last year. Could you explain what the deal is and does it open up any opportunities now or in the future?

DN: Yeah, it’s obviously pretty significant when you think about the countries that are, that are included we’re talking, you know, probably around 30% of global GDP and population, and it’s about, you know, bringing down a lot of the, of the tariffs and sort of trade barriers that are there. So you know, it’s obviously pretty significant. You know for me, as an investor, you know, investing in China, it’s probably less significant than I would say, probably if you were investing directly in some of the countries in Southeast Asia that, that sort of will have probably less fettered access to a lot of the markets, but, you know, it’s clearly, you know, it’s me a huge positive just in terms of reducing trade friction, trade barriers.

So I think over the long term you know, you’ve got to definitely view it as a positive, but as I said, for me, I’m focused more on the domestic opportunity in China. When I look across the sort of investment universe that I’m focused on, you know, you could pick out maybe some shipping companies, there are some textile companies that have, that have capacity in Southeast Asia that will clearly benefit particularly the ones that I think are selling into places like Japan. But, you know, again, for me, I’m really largely focused on the domestic opportunity in China, you know, the tech companies, the growth of the middle class, the consumer in general, areas like healthcare and that sort of thing. So you know a positive, but, you know, sort of no direct links to a lot of the companies I have in the portfolio.

[3:18]

CS: And obviously there’s only been one story that sort of dominated in 2020. Could you maybe give us a bit more of an insight on how China’s fared since the onset of the pandemic in the past year or so, and has the economy opened up? Are there more problems sort of coming down the road again now for, for the region?

DN: Yeah, so, you know, I think, you know, China overall has a really good job of getting things under control. Obviously it was you know, it was a pretty strict approach, strict measures in terms of lockdowns initially, but, you know, that will allow them to get the numbers down significantly. And on the back of that, recover pretty quickly. I’d say that the recovery probably started more on the industrial side or the manufacturing companies, you know, the ones that we are speaking to their sort of, you know, back to full production, you know, in the first half. For the more consumer related areas you know, the recovery has been slower, but sort of, you know, generally improving month by month. And I think towards the end of the end of last year you know, a lot of, you know, huge parts of China are just back to normal, particularly in the South.

Obviously of late we’ve seen, you know, some flare ups in terms of, in terms of numbers. And I think that’s had some impact. When we look at some of the numbers that we saw in, in December, we saw a bit of a slowdown. So, you know, retail sales sort of dropping below 5%, which is down on what we saw in November. And in discussions we have with, for example, some of the restaurant companies, some of the hotels, we’ve seen a bit of a drop-off, I think there’s probably a weather factor there as well. We’ve had some sort of, you know, pretty, pretty bad weather particularly in the North. So it’s probably a factor as well, but I think COVID is having, is having some impact. You know, having said that, I mean, the government reacts quickly. And you know, I think, you know, you’ve got to be pretty confident that they can definitely keep things under control.

[5:11]

CS: Sorry, I was going to say, I wanted to touch a bit more on the specifics of the portfolio. I noticed you’ve got 30% invested in US listed companies. Can you explain why this is please and sort of the types of companies that those holdings are in?

DN: Sure. So well, you know, I mean, I’m investing in China and so where the companies are listed is less of a factor for me. It’s really where their businesses are. And the fact is that a lot of the, you know, the tech companies are listed in the US so, you know, the likes of Alibaba, 21Vianet, and you know, in the tech space, but, you know, some non-tech names, names like Noah, which is a leader in wealth management, is also listed in the US. Obviously some of these companies are now listing in Hong Kong as well. But, you know, the fact is, you know, a lot of the particularly the tech companies are listed in the US.

[6:01]

CS: You mentioned tech, there’s about 15% of the trust invested in that sector. Could you maybe explain what other opportunities you’re finding in other sectors as well? Cause it’s maybe not as high as perhaps some people would think, and obviously it’s not impacted performance. Maybe just give us a bit of a snapshot of what you’re seeing?

DN: Yeah. That’s actually a bit misleading in terms of sector naming, in MSCI China right now, because you’re missing big swaths of companies, which are in many ways tech companies. So they’ll you know, most of the e-commerce companies come under consumer discretionary. So, you know, and then you put Alibaba in that category, and then you’ve got Tencent, which is in communication services. So those two names alone, you’ve got to sort of add 25% to the tech component. So it is actually pretty significant you know, in terms of sort of overall tech exposure.

You know, outside of tech you know, the areas that, that I think, you know, really have the, have the great long-term growth prospects in China, really anything consumer related. And that’s why you’ll see consumer discretionary is as a really big category for me, just, you know, really benefiting from the natural growth of the middle class in China. And the other area is healthcare which, you know, will continue to grow in China. There’s a lot of government support. But there’s just a huge amount of development activity in China now. So I focused on the companies that are really doing particularly innovative work in that space in China, it’s pretty exciting growth area for the long term.

[7:37]

CS: And sort of as we sit here, maybe just give us your outlook for China this year for 2021, and what excites you most, and maybe talk us through some of the threats you’re also wary of in the, in the region.

DN: Well you know, I still think, you know, there’s a lot of opportunity. It’s a market, you know, I think just looking at the economic backdrop you know, we’re, as you’ve seen, you know, China was really the only large economy to grow last year. The outlook still looks pretty good for this year. And I think sort of most people are forecasting sort of growth around the 8% level. And you can assume that consumption is sort of growing faster within that category. So I think, you know, the backdrop looks good as we’ve talked about with COVID. I think there’s probably a lot more uncertainty in other markets relative to China. We know that they have a pretty good track record of keeping things under control. So I’d say the risks are relatively, relatively low as well.

And, you know, if we were going to talk about risks I’d say, you know, clearly the valuations are not as compelling as they were, you know, when you know that we sort of sort of, obviously at the beginning of last year, with the market sell-off. And there’s clearly some frothiness in parts of the market. So I think you need to be, you know, you need to be wary of that. Additionally, we’ve got, you know, obviously signs of regulation in a number of sectors, particularly the tech sector. So we need to sort of watch how that plays out. You know, I, you know, there will be opportunities, obviously the focus is on the larger companies, so, you know, we’ll see how it plays out, but there could be opportunities for smaller companies as a result of that. But overall I’d say, you know, the, overall backdrop still looks, it looks pretty positive. It’s just going, I think it’s going to be a market where you’re going to have to focus a lot more on, on stock picking, as opposed to just relying on, on performance of the overall market.

[9:36]

CS: Are you holding back a bit of cash for those opportunities you mentioned, or how are you sort of playing that?

DN: Well, as, you know, as a closed ended fund, we have gearing. I have you know, sort of brought the gearing back slowly it’s, you know, as things have moved up, you know, it’s been it’s been an opportunity to take some money off the longs added to, you know, some of the, some of the short opportunities. So, you know, I’m finding that the net gearing sort of, you know, gradually coming down you know for those reasons.

CS: That’s great Dale, thank you very much for joining us today.

DN: Great. Thanks a lot.

CS: And if you’d like to learn more about the Fidelity China Special Situations trust, please visit fundcalibre.com and while you’re there, remember to subscribe to the Investing on the go podcast.