Dale Nicholls, Anthony Bolton’s successor as manager of the Fidelity China Special Situations (FSCC) investment trust, has argued that Chinese state-owned enterprises (SOEs) should not be deemed a ‘no go zone’ as many are trading on ‘pretty attractive valuations’.
Citywire AA-rated Nicholls said while he preferred to invest in private companies, the state sector should not be ignored.
He said reforms that will partially privatise some of the state sector will benefit both private companies and SOEs.
‘Generally, I prefer the private companies and those are the ones most likely to benefit from the reforms we are seeing,’ Nicholls said.
‘Having said that, you still need to monitor the SOEs: a lot of them are trading on pretty attractive valuations and could also benefit from some of the reforms we are going to see coming through.’
Nicholls (pictured) said the current low levels of valuations in the state sector reflected a wider bearishness on China, which he would also be looking to exploit.
‘The valuations are nearing historical lows, so it shows you just how negative sentiment is towards the market right now. I would say valuations are pricing in pretty significant risks, so now is a pretty interesting opportunity to be invested in the market given just how low valuations are.’
‘That is as well as the mid-term growth potential story which hasn’t really changed and as soon as we get over some of those macro risks, I think the potential is there for the market to do quite well.’
Nicholls said IT and consumer stocks were poised to benefit the most from China’s reforms. Those sectors make up a combined 45% of the trust.
‘The sectors that are best positioned to benefit from a lot of those reforms we are seeing are those “new China” sectors,’ Nicholls said.
‘In areas like consumption, IT, which is really internet names and the software names, and pharmaceuticals, those are the areas that are really going to benefit from some of the reforms. Consumption in the mid-term really is the most interesting part of the China story over the next five-to-10 years.’
Fidelity China Special Situations shares have returned around 10% since the trust’s launch in April 2010, ahead of its benchmark, the MSCI China index. However, those figures hide a volatile time for investors: the trust lost 37.9% in its first full year – 2011 – more than double that registered by the benchmark. Strong performance in 2013 helped it recover ground. Since Nicholls took over the fund in April this year, shares in the trust have risen 9.5%, lagging the benchmark.
The trust is currently trading at a 9.6% discount and Winterflood analyst Simon Elliott has questioned why it has not issued a tender offer. The trust’s rules allow it to issue a 15% tender offer up to twice a year at a discount of no more than 5% to the net asset value.
‘Although we are wary of simply offering liquidity when asset classes are out of favour, as China clearly is at the moment, the far bigger issue here is that many investors in the fund bought Bolton first, China second.
‘Therefore, there was always likely to be significant numbers seeking an exit on his retirement. By not immediately producing plans to hold a tender, the fund’s discount was always likely to widen despite buybacks.’