TIDMFCSS
Fidelity China Special Situations
29 July 2021
Fidelity China Special Situations PLC: Update from Portfolio
Manager
Today, Dale Nicholls, Portfolio Manager of Fidelity China
Special Situations PLC has published the following comments:
"I wanted to personally share my thoughts on the sharp sell-off
we saw in Chinese equities earlier this week and hopefully, put the
regulatory news flow into perspective.
The recent downturn in the Chinese stock market was primarily
driven by the government announcing an extensive regulatory
overhaul of the education sector last Friday. These new policy
measures have a devastating impact on the After School Tutoring
(AST) space - not only will classes be significantly limited but
they will need to be non-profit, cannot be funded by listed
entities, and foreign ownership will be restricted. It appears the
overall aim of these reforms is to reduce the cost of education on
children and families.
From a portfolio perspective, the trust has a relatively small
exposure to the education sector, with a small position in China
Online Education - a company that provides a platform for foreign
teachers to teach students English. While we have been wary of
potential regulatory changes to the AST segment and I exited from
other AST stocks earlier this year, I didn't factor in the
likelihood of a ban on overseas teachers - clearly a misjudgement
on my part.
Naturally, a key concern for investors is how these education
reforms coincide with the heightened level of policy developments
we have seen in China over the past six to twelve months.
Industries such as mobile payment providers, consumer finance and
ecommerce names have been targeted by regulatory changes relating
mostly to antitrust and data security issues. There is particular
sensitivity to overseas listings by data-heavy companies, and we
have seen with the recent listings of Didi. This seems likely to
drive many more companies back to listing on the Mainland and Hong
Kong.
From a timing and historical perspective, it is certainly not
the first time we have witnessed heightened regulation in China. We
only need to cast our minds back to 2018 when the government felt
the younger generation was spending too much of their time playing
online games and as a result halted new gaming licenses. This was
clearly a factor driving a near 50% correction in Tencent's stock
price before rebounding. Markets dislike uncertainty but we have
since seen Tencent's shares rally 200% since the low in October
2018 to their high in January this year and up 77% using
yesterday's close post the clarification of these "rules". While
not without some risk, history teaches us that these times can be
the most opportune to invest - attractive valuations coupled with
conviction in a company's business model, management team, and the
long-term opportunities.
In terms of valuations, we are seeing many companies in the tech
space now trading at historical low valuations, and at significant
discounts to global peers. We acknowledge that there is potential
for business models to change and are accordingly, adjusting down
our expectations around monetisation levels in certain companies.
Having said this, investment is all about risk-reward and for many
names, this is looking favourable after recent moves.
Although it is tempting (One could even argue logical) to
connect the regulatory changes to the internet sector to what has
happened in the education segment, we see them somewhat
independently. The thrust of the regulatory changes in the internet
space has been around anti-trust and data security, policies which
have been in the works for some time and in many ways have lagged
other countries in terms of basic "infrastructure". Politically,
education is a very sensitive area and also represents one of the
so-called "Three Mountains" - areas where cost pressures can
exacerbate income gaps in society (clearly, an issue not just in
China but a global problem). The other two "mountains" are medical
services and housing. We see regulation around these three areas
becoming more prominent - obviously something we are very focused
on as investors. Given our weighting in healthcare we are watching
developments closely, but my sense is that policy moves are already
quite progressed (for example, most price cuts are focused on
generic drugs versus the government's goal of developing home-grown
innovative drugs).
Whilst we can't predict the details of every single policy move
(such as the recent one around education), it is important to keep
in mind the historical context and the longer-term goals that have
been laid out. China has clear priorities around economic growth
including doubling its GDP per capita (once again) by 2035. Nobody
could argue that a vibrant and healthy private sector isn't
essential to achieving this aim. Priorities around innovation are
also clearly rising - many of the companies in the sectors we are
talking about are not only big employers and drivers of growth, but
also drivers of innovation. Also, China has made no secret about
its goals around developing its capital markets and
internationalising the RMB. Clearly, the creation and evolution of
a stable investment environment - for both domestic and foreign
investors - has to play a part. In this regard, we have already
seen press statements from policy makers seeking to calm markets
and last night, the regulatory body (CSRC) held a meeting with
banks and financial services companies to highlight their rationale
for these specific AST reforms; the ADR market and the HK/China
markets have rallied on the back of this news.
I'd like to finish off by reiterating that government regulation
is a constant in China - any investor must accept and incorporate
this into one's risk/reward framework. Many new policy initiatives
are still evolving and certainly can cause uncertainties which is
why it is key for me and Fidelity's analysts to continue to
incorporate this factor into our assessment of long-term business
prospects for a business, and how corporate management teams and
their business models are positioned. Investing at the end of the
day comes down to risk reward and with the correction we have seen,
this is tipping in our favour. Yes, sentiment is poor, but it
usually is at the most opportune times.
Take care and all the best,
Dale Nicholls
Portfolio Manager - Fidelity China Special Situations PLC
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