Fidelity China Special Situations Plc

The time to “be greedy when others are fearful”?

18 Mar 2022 / Corporate research

One of Warren Buffett’s more famous quotes is to “be fearful when others are greedy, and be 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 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.

  • Risk: The key to understanding risk exposures is to analyse why they are happening. By way of example, looking at regulations of large companies, we believe the key driver is the long-term threat such businesses may pose to government power. By looking at that, investors can focus on which companies regulation will target.
  • Opportunities: Market dislocations create stock-specific pricing anomalies. Research by a long-established, large, local team is 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.
  • Valuation: FCSS’s portfolio is largely listed equities. It trades at a 0.7% discount to NAV. The discount has been falling since 2016, but recently rose on the concerns above. Peer ratings have been volatile (FCSS in the pack), but its performance is significantly better. The yield is now 1.8%, and buybacks have recently been done.
  • Risks: Further regulation in China is a risk, but FCSS’s exposure appears limited, and noise around the issue can create investment opportunities. Geopolitics may affect sentiment, but FCSS is domestically focused. Sentiment can go against FCSS’s investment style, and returns are expected to be volatile.
  • Investment summary: In general, FCSS invests in the huge opportunities from New China, with growth in the middle classes and supportive government policies towards domestic demand and innovation expected to underpin superior GDP growth. Fidelity’s stock-picking, gearing, being able to make illiquid investments, and the compounding benefits from investment outperformance have seen total share returns ca.2x the market since launch. There are risks from further regulations, but these may also create opportunities. Investor appetite for FCSS’s style may vary, and investors should expect volatile returns. As noted, the share price is at a 0.7% discount to NAV.
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