Fidelity China Special Situations plc (LON:FCSS) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: You called your report on Fidelity China Special Situations, The time to “be greedy when others are fearful”? What is your brief summary of it?
A1: One of Warren Buffett’s more famous quotes is to “be fearful when others are greedy, and greedy when others are fearful.”
In this note, we explore what is making some investors fearful of China, identifying three key risks: i) regulation; ii) geopolitical tension; and iii) COVID-19. All three were explored in detail in our initiation. Understanding why regulations are being introduced means that investors can identify companies that will be affected and when restrictions will end. Geopolitical tension, while harder to assess, is at above normal levels, but this is not new. China has managed COVID-19 well. Pricing anomalies create research-led new opportunities.
Q2: How can a manager like Fidelity add value in times when regulatory risk is high?
A2: We highlighted, in our initiation, and again in this note, that the key to understanding risk exposures is to analyse why they are happening. On reading some articles, one might believe that every Chinese technology company has seen its share price collapse under the weight of regulatory pressure. This is simply not the case. Deep fundamental analysis, using extensive experience, of both the market in question but also of regulatory risk in other markets, can give insights as to which companies are, and which companies are not, exposed to regulatory risk. By way of example, we highlight SenseTime Group, which, at the end of January 2022, was FCSS’s fifth-largest holding and its third-biggest overweight position as a percentage of net assets against the index.
Q3: So what do you see as the Chinese government’s objectives?
A3: First, concerns about social inequality ‒ in China, the top 10% share of national income has risen from just over 30% in 1990 to an estimated 42% now, while China’s share of wealth has increased from just over 40% to nearly 70%. For a communist country, it is not surprising that such a trend may be a cause for concern, and we note that Chairman Xi’s slogan of “common prosperity” appears to have been gaining increasing traction.
Second, data protection and technology are about national security. The focus is on access to data, rather than infrastructure and systems, and it is companies with such access that would appear most at risk.
Third, in our view, Chinese authorities have a long-term focus, and threats to the Communist Party control could arise if money and power were concentrated in just a few private or overseas hands.
All three factors will lead to regulations being targeted on specific companies, and not applied across all companies. The bottom line is that China needs strong growth to ensure social cohesion, and this needs a strong dynamic business sector – so we were not surprised by the positive government announcements on 16 March.
Q4: And what about geopolitical risk?
A4: We believe that geopolitical tension is nothing new in the relationship between global superpowers. The conflict in Ukraine has added a new, potentially, very serious dimension, but it just adds to an already long list, including Hong Kong, trade deficit, intellectual property, Uyghur and human rights. We expect geopolitical tension to ebb and flow; at present, it is above normal, but tension will be part of the normal course of business over the long term. Looking at some of FCSS’s share price reactions, or rather non-reactions to specific events in the past, we note that the Hang Seng rose by 30% in the 10 months after the 1991 Gulf War, having fallen 20% in the initial uncertainty around it.
Q5: And COVID-19 coming back?
A5: The number of cases in China remains tiny in comparison with what we are seeing in the UK. Yes, the Chinese government is taking very draconian action in locking down huge numbers of people, but this proved very effective in the first two years of the pandemic, when China recorded much stronger growth than the rest of the world.
Q6: Finally, you highlighted that these risks also create opportunities?
A6: Market-wide dislocations create stock-specific pricing anomalies. If all share prices fall, the companies that are not affecting the risks are mis-priced. Deep, fundamental research by a long-established, large, local team gives Fidelity China Special Situations a competitive advantage over global players, while access to Fidelity’s global analysts and the manager’s regional experience give a perspective unavailable to domestic peers. Its competitive advantage increases with the number of opportunities.
