Dale Nicholls, manager of the Fidelity China Special Situations (LSE:FCSS) investment trust, tells interactive investor’s collectives editor Kyle Caldwell why he thinks the outlook has much improved for investing in China. Nicholls explains how he moved to take advantage of low sentiment and cheaper valuations, names a favoured consumer stock and gives his opinion on the regulatory headwinds that have held the market back in 2022. He also gives his view on recent performance, which saw the trust’s share price fall around 50% from 1 February 2021 to the end of October 2022.
Fidelity China Special Situations investment trust is a member of interactive investor’s Super 60 investment ideas.
Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Dale Nicholls, fund manager of the Fidelity China Special Situations Investment Trust. Dale, thanks for coming in today.
Dale Nicholls, fund manager of the Fidelity China Special Situations Investment Trust: Thanks, Kyle. Great to be here.
Kyle Caldwell: So, Dale, it's been a challenging couple of years to be investing in China. One of the main headwinds has been the zero-Covid policy. Now that that's been relaxed, are potential brighter times ahead?
Dale Nicholls: I think absolutely. If you think about what's held the market back, there's a few things. Obviously, the regulatory storm that we've been through, what's going through in the property sector. But I'd say, definitely the zero-Covid policy, the lockdowns, have been a real constraint on just economic growth in general and the market as well, just that mindset around that as well.
So clearly, we've got through things pretty quickly and I think from here the outlook looks pretty bright. I think China will be one of the few large economies that has accelerating growth this year in terms of economic growth and likewise probably accelerating earnings growth as well, and we're seeing earnings upgrades come through as well. So, I think it's stacking up well relative to a lot of other markets.
Kyle Caldwell: And have you been making changes to the portfolio to take advantage of the lower valuations on offer? Are there any sectors you'd pick out that you've been increasing exposure to, or any new companies?
Dale Nicholls: Absolutely. So, through last year, as we saw a significant sell-off, [and] record low valuations, that threw up quite a few opportunities. I think, those sectors that were impacted by the lockdowns were clearly the ones that got very cheap. So, in the consumption space, that was an area of increase for me. So, when I think about the changes in the portfolio over the past 12 months, consumer discretionary is probably the biggest area of increase with the view that things had to open up. I think things have probably opened up faster there and earlier than we expected.
But the outlook for the consumer is clearly very strong. It will be the main driver of growth this year. I think the prospects are pretty good. You've seen a real massive increase in household savings through this period, through the Covid period, and obviously people have been locked up for three years. So, I think there's a lot of pent-up demand [to] be released.
I think clearly you need to see some bottoming in the property sector. So, the mindset around property, obviously, the consumer in China has pretty significant exposure on their balance sheets to property. So, if we see things start to bottom in the property sector, I think from a consumer confidence point of view, the prospects are clearly strong in the whole consumption space. And then I think beyond that, you can look to a broader economic recovery. So, the industrials and [what’s] also interesting is the financials. If you think about the potential for increase in credit growth, improving credit quality, again, more regulatory clarity in some sectors. I'd say that's an area that's been a laggard. But the prospects in terms of fundamentals improving actually looks pretty good.
Kyle Caldwell: Could you give us a couple of examples of consumer stocks that you own in the portfolio?
Dale Nicholls: I'm thinking of a company called JNBY Design (SEHK:3306), which stands for Just Naturally Be Yourself. An interesting name. But this is a company that does relatively high-end, kind of edgy, apparel. In many ways competing with some of the foreign brands, but doing a good job at that, quite an innovative company, with a good track record of growing the business over time. So again, as things open up and people are heading outdoors more, I think there's good prospects for a recovery there, and you're paying quite a low multiple single-digit earnings for a business that has a good track record of growing over time and should benefit from some recovery.
Kyle Caldwell: And how do the valuations of the companies that you own compare today to history, for the trust?
Dale Nicholls: If you look at that over time, average valuations for the trust have probably been around 15 times forward earnings and now we're probably in 11 to 12 times range for the trust. So, in line with the market overall. That's recovering from a bottom of probably closer to eight or nine. So obviously, we've had a pretty nice bounce from the bottom as prospects have improved. But, from a historical perspective, still reasonably cheap. So, I think there’s still pretty good prospects in terms of that multiple potential to expand.
Kyle Caldwell: As you touched on earlier, one of the headwinds has been the regulatory changes to the technology sector, and another area of concern is debt levels in the property market. What are your views on those two areas of concern?
Dale Nicholls: It’s been, as you say, a tough period for the property sector. I think it's important to keep in mind that a lot of the correction is due to tightening regulatory policy, and now we're in the process where a lot of that tightening regulation is being unwound.
So, I think [if] that continues, there's more potential for lower deposit rates, lower deposit levels on properties and that sort of thing. So, the prospects for things improving are actually pretty good. I'm not so concerned about the individual consumer as we've talked about, the consumer balance sheet is in pretty good shape. Cash levels have picked up, but it's been a tough time for the developers, particularly the private developers. So, it's important to be selective when you're looking at the market and really focus on the developers that have the strong balance sheets. I'd probably favour the state-owned developers versus the private developers at this point in time.
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Kyle Caldwell: As mentioned, it's been a tough short-term period and if I took the time period from the 1 February 2021 to the end of October 2022, the share price of the trust would be down 50%. Does that sort of drawdown show the risks of investing in China?
Dale Nicholls: You have to be honest; China is a volatile market. It tends to be fairly driven by headlines, whether it's about economic growth [or] geopolitics. It tends to be in the headlines and the market is volatile as a result. And sentiment can swing significantly, but as you know, I'm very focused on individual companies, their ability to grow earnings to realise and create value over time.
So, as an individual investor focused on individual companies that can throw up great opportunities. So, when the market is impacted by these headlines, that can create good opportunities. You've seen us capitalise on that last year with the downturn. So, we actually put more money to work. We saw the gearing and the portfolio pick up. We've pulled that back somewhat with the recovery. I'd just say that volatility in the market is really what can create a lot of opportunities for the investor.
Kyle Caldwell: And does it also show that investors should be patient and think long term, particularly investing in a China-focused strategy?
Dale Nicholls: Yes, absolutely it's important to have that long-term view. That's what we do when we look at individual companies, we think about the prospects for individual businesses over the longer term. So, I think likewise, for investors take the long-term view as we do.
Kyle Caldwell: Dale, thanks for coming in today.
Dale Nicholls: Thanks, Kyle.
Kyle Caldwell: That's all we have time for today. You can check out the rest of our Insider Interview on our YouTube channel, where you can like and subscribe. Hopefully, see you next time.
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