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You’re buying China at 2008 prices, says Fidelity’s Nicholls

17 February 2016

The manager of the Fidelity China Special Situations investment trust argues the recent falls have made the Chinese stock market absurdly cheap

By Daniel Lanyon,

Senior reporter, FE Trustnet

Investors buying into the recent plunge in the Chinese equity market are getting close to the prices paid during the 2008 financial crisis, according to Dale Nicholls, manager of the Fidelity China Special Situations investment trust, who adds even by avoiding pariah bank stocks the index is looking very cheap.

Few can have escaped the fact that the Chinese stock market has come crashing down over the past year after a rapid rally, with banking stocks some of the worst affected due to concern they are overly indebted and highly exposed to slowing economic growth.

In price terms, the MSCI China – which is the index UK investors are most likely to access – is today below its level on 1 January 2008 but is still somewhat off its financial crisis bottom in October of the same year.

Price performance of index since 2008

Source: FE Analytics

It has fallen ‘just’ 40 per cent since April 2015, whereas it fell 54 per cent in 2008.

Nicholls is ignoring the banking sector like many other investors but says even disregarding these stocks – which generally are on mid-single digit price to earnings ratios – he is buying to similar prices as in 2008.

Nicholls said: “It is not quite too the same depth but it is close. If you take out the banks you are on about 11x earnings for MSCI China. Of course not all stocks are back to that same level but they are looking pretty compelling.”

“There are a lot of stocks that you can buy well below book value with strong cash flows. My sense is that a lot of bad news is already priced in.”


He attributes the ‘cheap’ valuations to the profound drop in sentiment to the region which not long ago was the poster boy market of significant emerging market growth.

“It is those broad macro concerns. Slowing growth, rising debt and the new one is the potential currency downside. The other factor which people used to be concerned about is property, which has since become less of a factor – the worry that there is a property bubble and we have a collapse coming,” he said.

“China’s Lehman moment [in banking] is not going to happen,” he added.

Nicholls has upped gearing in the trust recently to just under 30 per cent, while the discount has moved very close to its widest level since launching almost six years ago. The manager has also reduced short positions and increased long positions.

Initially headed by former star manager Anthony Bolton, Fidelity China Special Situations was one of the most keenly anticipated investment trust launches in history.

As a consequence it was heavily oversubscribed when it listed in April 2010, meaning it moved to a hefty premium of 14 per cent within months. Since then it has seen a falling premium move to an ever widening discount with little interruption.

Several fund managers and commentators have started to become more optimistic for a turnaround in sentiment towards China of late, including Patrick Cadell, manager of the Liontrust GF Global Strategic Equity fund.

The market is currently gripped by utter panic, and fails to appreciate that the current slowdown is part of a carefully controlled effort to rebalance the Chinese economy for sustainable long-term growth.”

“As such, it remains our view that the current dislocation between perception and reality is a buying opportunity, and in light of the significant risk/reward on offer, are we are willing to ride the volatility.”

“The HSCEI Index of H-Shares is now trading on 0.7x price/book, having only ever been lower during the Asian financial crisis of 1998. In other words, if China is indeed experiencing a ‘hard landing’, a large part of this is already in the price.”

Nonetheless, the economic data suggests that growth is stable, he adds.

“There is currently no evidence whatsoever that this will deteriorate into a hard landing. The government is making significant progress in rebalancing the economy away from excessive and unsustainable investment, and towards consumption.”


 

Since Nicholls took over the Fidelity China Special Situations investment trust in April 2014 the closed-ended fund is up 16.09 per cent versus a 3.84 per cent gain in the index.

Performance of trust and index under Nicholls

Source: FE Analytics

However, the trust’s growth in its underlying portfolio – or net asset value (NAV) – has been 60.87 per cent over the same period, showing the impact of the widening discount on total return.

Performance of trust’s NAV since launch

 

Source: FE Analytics

Fidelity China Special Situations has an ongoing charges figure of 1.35 per cent and a performance fee which most recently totalled up to 2.00 per cent. Gearing is 28 per cent.

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