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A-share MSCI announcement

"Value is a good China strategy" 

By Jing Ning, Portfolio Manager, Fidelity China Fund 

The Fidelity China Fund is Fidelity’s flagship China offering, managed by Jing Ning. We would like to share her thoughts on A-shares and her outlook for the Chinese markets.

The opportunities arising from the inclusion of A-Shares to the MSCI China Index NR1
China’s domestic A-share market is the second largest stock market in the world (See Chart 1). Across the Shanghai Stock Exchange, Shenzhen Stock Exchange and ChiNext, it is home to a range of blue chip stocks representing well-established business models with strong pricing power and robust cash flows. 

Many of these companies are also exploring international markets, expanding their product lines and entering new market segments, but this is not widely recognised. So far, this market is dominated by retail investors, who are influenced by short term swings in sentiment as well as willing to overpay for growth levels that are not sustainable over an economic cycle.

The long-awaited inclusion of A-shares in MSCI China will help institutionalise this market and make the opportunity in A-shares more widely recognised. This will potentially increase the liquidity levels, introduce comparatively stable flows into the market and overall, it would be a noteworthy positive development for the smooth functioning of the market. I have had a positive view of the government’s efforts so far towards increasing institutional participation in the Chinese stock markets - the Stock Connect programs in recent years were a step in the right direction to facilitate it. 

Chart 1: The second largest market in the world2

Source: Bloomberg, May 2017

A-shares have been a key component of the Fidelity China Fund
I prefer durable business models that offer earnings visibility from a three to five- year perspective, are currently unnoticed by the larger market and trade at attractive asset-based valuations. A-shares have been an attractive ground for investment ideas for a contrarian value investor such as myself. 

China is widely perceived as an ideal market to search for growth. The reality is that it is a unique and policy-driven economy. The extent of policy and government regulation make it a complex market to navigate, and the regulatory framework evolves at a fast pace. China is also a competitive market with an abundance of capital and talent, and therefore, any successful business model or approach is quickly replicated. 

As retail investors seek quick growth, they tend to rotate away from value in A-shares - the generally less-exciting businesses with relatively steady growth prospects, high dividend yields and attractive valuations to their global peers. Such a backdrop is suitable to my investment approach. It allows me to research these stocks in depth, avoid value traps and steadily build long-term positions in robust businesses. Several stocks that are listed only in the A-share market provide a route for the long-term investor to benefit from the structural shift towards a consumption-driven Chinese economy. For instance, Chinese home appliance manufacturers only have domestic A-share listings (see Chart 2 below).  

Chart 2: No. of stocks in sectors listed only in the domestic A-share market 

Source: Bloomberg, May 2017

I have been a long-term advocate of the mainland Chinese market, even though it is not represented in the MSCI China Index this far. Fidelity’s US$ 1.2 billion QFII (Qualified Financial Institutional Investor) quota, the largest quota available to a foreign buy-side asset manager, has provided access to the A-share market since the beginning of my tenure (See Chart 3 below which shows the Fund’s exposure over my tenure).

Chart 3: Fidelity China Fund A-share exposure over Jing Ning’s tenure (1 November 2013)


Source: Fidelity International, May 2017


How have A-shares contributed to the Fund performance?
Selected A-shares positions in Gree Electric Appliances, China CNR Corporation (now CRRC Corporation), SAIC Motor, Zhejiang Supor Cookware and Fuyao Glass have been among top contributors to returns over my tenure (1 November 2013). I stayed invested in these off-benchmark names despite the extreme swings in sentiment during 2015 in Chinese A share market. I continue to retain exposure to these positions as I favour the prospects of these A-share names. 
 
Gree is the market leader in air conditioning and a technology innovator, and continues to be a top holding. Railway equipment manufacturer China CNR merged with locomotive manufacturer CSR to form CRRC Corporation. This merger was well received amid expectations of operational synergies and greater export competitiveness, and the holding made a noteworthy contribution to returns. SAIC Motor is a beneficiary of Shanghai government being an early mover in state-owned enterprise (SOE) reforms and its strong global partnerships with renowned automobile manufacturers. Zhejiang Supor relies on its French parent’s SEB research & development as well as product innovation to capture domestic market share. It also serves as a production base for SEB’s international demand. Fuyao Glass is the world’s only pure automobile glass player going global and steadily gaining global market share. 

Outlook for the remainder of 2017
The Chinese economy has been in a muddling through stage since the investment cycle peaked out in 2010. The government is focused on the twin objectives of growth stabilisation and reforms. Since the second quarter of 2016, we have seen an improvement in the real economy aided by corporate capital expenditures, consumption and exports. China is also emerging from a period of industrial deflation, and the unique supply side reforms have helped in better supply dynamics and removing excess capacity. So far, we have seen these state-led capacity cuts in coal and steel, industries such as glass, cement, paper and refining are next on cards.
 
We are also seeing a shift in the outlook towards shareholder returns, with institutionalisation of the domestic market as a clear goal. For instance, China does not have a dividend culture, but, we saw signs of change early this year - our preferred holding China Shenhua, the lowest cost coal producer in China, issued a special dividend for the first time in its history, as it benefited from higher coal prices following the supply side reforms.
 
At the same time, China has a huge and complex financial system. This year, the government is likely to focus on deleveraging and regulation. The People’s Bank of China (PBoC) has been more proactive than prominent Western central banks, and raised its interbank lending rate over 100 bps in 9 months. This tighter liquidity environment is favourable for the big banks with stronger balance sheets and reflects that the economy is stabilising, which will allow the government to pay attention to reforms.
 
Current positioning of the Fund 
I do not prefer any themes (such as old China vs. new China, SOE vs. private sector); I go where the value opportunities are to invest in stocks that fit in my framework. At the end of May 2017, the fund had noteworthy exposure to energy and materials sectors as an aggregate of my bottom up security selection. Cement producer Anhui Conch offers better regional exposure and is supported by a high-quality management team, low costs and a strong balance sheet. Among energy positions, CNOOC and China Petroleum & Chemical are key overweight holdings. 
The fund also has key preferred holdings in financials, where China Life Insurance is the fund’s largest overweight holding. China Life is likely to gain new business at higher value, while the government has a favourable policy approach to grow the insurance sector in China. The fund is overweight in its exposure to China Merchants Bank given the management’s focus on risk control. The bank has been ahead of its peers in recognising non-performing loans and maintains prudent lending standards.
 
Meanwhile, Gree Electric discussed above remains a top conviction holding. I also retain my conviction in railway equipment companies ZhuZhou CSSR Times and Guangshen Railway as beneficiaries of the state’s emphasis on high speed railways infrastructure. I remain optimistic about the prospects for state-owned real estate developers. China Overseas Land and Investment is held for its strong revenue prospects, low debt and solid execution track record. Its strong balance sheet can support future land acquisitions and potential merger and acquisition opportunities.
 
As a bottom up stock picker, my investment decisions are driven by research and analysis. The fund remains notably underweight information technology sector given my concerns about the underlying fundamentals being able to sustain valuation premiums. Instead of increasing the fund’s exposure to internet names as a response to the change in the index’s composition, I diverted this exposure to A-shares.
 
About Jing Ning
Jing Ning took over the management of the Fund on 1 November 2013 and the Fund has delivered 14.36% p.a. since inception3 vs 10.76% p.a. delivered by the MSCI China Index NR4
 


Source: Fidelity International, May 2017

Jing is a contrarian value investor with 18 years of experience in investing in the Chinese stock markets. She has a clear preference for durable business models that offer earnings visibility from a three to five-year perspective, are currently unnoticed by the larger market and trade at attractive asset-based valuations.

 

 

 

1MSCI China Index. NR: NR at the end of the benchmark name indicates the return is calculated including reinvesting net dividends. The dividend is reinvested after deduction of withholding tax, applying the withholding tax rate to non-resident individuals who do not benefit from double taxation treaties.

2Market cap data as at 30 April 2017

3Inception date: 29 September 2005

4Total net returns represent past performance only. Past performance is not a reliable indicator of future performance. Returns of the Fund can be volatile and in some periods may be negative. The return of capital is not guaranteed. *The returns shown have been calculated using the net asset value of the Fund from one period to the next. The returns include any re-invested distributions and are after fees and expenses. No allowance has been made for taxation or for any fees charged by operators of master trusts or wrap accounts through which the products are offered. For periods greater than one year returns have been annualised. Growth return is the unit price movement on exit to exit basis. Income is expressed as Total Return less growth component. 

This Fund is unhedged and is subject to the risk of fluctuations in international stock markets and currencies. Investors accessing the Fund through a master trust or wrap account will also bear any fees charged by the operator of such master trust or wrap account. Any apparent discrepencies in the numbers are due to rounding. 

This document issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 ("Fidelity Australia"). Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International. 

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment. Investments in small and emerging markets can be more volatile than investments in developed markets. 

This document is intended for the use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation and needs. You should consider these matters before acting on the information. You should also consider the relevant Product Disclosure Statements (PDS) for any Fidelity Australia product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading it from our website at www.fidelity.com.au. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity's managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless otherwise stated. 

© 2017 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited. 

 

This website is intended to provide general information only and has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information and consider the relevant Product Disclosure Statement for any product named on this website before making an investment decision.

© 2017 FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340.
Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL limited.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 ("Fidelity Australia"). Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International. Prior to making an investment decision retail investors should seek advice from their financial adviser. Please remember past performance is not a guide to the future. Investors should also obtain and consider the Product Disclosure Statements ("PDS") for the fund mentioned in this document. The PDS is available on www.fidelity.com.au or can be obtained by contacting Fidelity Australia on 1800 119 270. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider such matters before acting on the information contained in this document. This document may include general commentary on market activity, industry or sector trends or other broad based economic or political conditions which should not be construed as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be construed as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care no responsibility or liability is accepted for any errors or omissions or misstatements however caused. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity funds is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. References to ($) are in Australian dollars unless stated otherwise. © 2017 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International, and the Fidelity International logo and F symbol are trademarks of FIL Limited.