According to City folklore, the Chinese word for crisis is made up of two characters, one signalling danger, the other opportunity. With the media fearing an imminent Chinese crackdown on the protesters in Hong Kong, the danger for investors is clear.
But if those fears are misguided, the current uncertainty may present an opportunity. The latter seems much the most likely, with the Chinese authorities exercising some restraint and anxious not to destabilise carefully cultivated relations with other emerging economies.
Stocks are hard to ignore
A major disruption to the Chinese economy and stockmarket looks unlikely. As Dale Nicholls, the manager of Fidelity China Special Situations Trust (FCSS), explains, "the Chinese economy may have slowed, but it is still... growing at over 6% per annum. Over time, the consequent growth in corporate earnings must be reflected in the value of investments." What's more, "though China has a mid-teens share of global GDP, until very recently it represented less than 3% of global markets, so that share will continue to grow. China is becoming much more difficult to ignore and should, in time, represent 40% of the global emerging markets index."
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With £1.7bn of assets, the Fidelity China Special Situations fund (LSE: FCSS) is the larger of two UK-listed trusts focused on China. It was launched in 2010 with Anthony Bolton at the helm. Bolton handed over to Nicholls in 2014.
In the last five years, the investment return has been 115%, beating both its rival JP Morgan Chinese (LSE: JMC), with £300m of assets, and every other emerging-markets trust. But over one and three years, JMC is well ahead, returning 4% and 64% respectively, compared with -6% and 37% for FCSS. Both trusts have large holdings in the two Chinese technology giants Alibaba and Tencent; a combined 20% for JMC and 24% for FCSS, and both have borrowings to boost investment returns of about 20% of net assets.
But just 25% of FCSS's portfolio is in firms with a market capitalisation above £10bn, compared with 73% for JMC, and 28% is in small companies with a market value below £1bn, compared with JMC's 2.4%. As Nicholls points out, small caps have underperformed the MSCI China index over the last two and a half years by a cumulative 50%. Should this reverse, FCSS can be expected to catch up.
Moving up the value chain
Despite FCSS's policy of share buybacks, its shares trade on a 10% discount to net asset value, compared with an even higher 13% for JMC, reflecting, perhaps, lingering distrust of China and the profit motive of its companies, many of which are state-controlled.
If so, this is not justified as JMC explicitly states that it focuses on "New China; companies... capitalising on the transition of the country to a more consumer-driven economy". As for FCSS, "New China opportunities remain incredibly exciting", says Catherine Yeung, investment director at Fidelity. "When we visit companies we see... automation, heaps of research and development and a lot of innovation. The government is encouraging companies to climb up the value chain rather than just be... manufacturers."
Encouraged by the success of investing in Alibaba before its flotation, Nicholls has invested 6% of the portfolio in unlisted companies with "exactly the same process" as for listed ones. This is risky, but it could pay off, as the punt on Alibaba did. Choosing between the two excellent trusts is tough. FCSS's mostly small and mid-cap strategy should succeed, as it has before, but there are also opportunities for JMC's big caps. The long-term confidence of both looks justified.
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Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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