Mark Dampier: Betting against the consensus on China


Fidelity China Special Situations has had a fair amount of bad publicity since its launch in 2010, much of which was poorly informed, in my view. My sympathy therefore to Dale Nicholls, who assumed management of the trust in April last year.

However, he has risen to the challenge admirably and patient investors have been rewarded: the trust’s share price reached a peak in May this year. Performance was undoubtedly aided by the Chinese stockmarket rally from mid-2014 to early June 2015 but good stock selection also had a material effect.

Given its dramatic take-off, the rally received much media attention. In my view, it had two main drivers. Firstly, unlike other markets that tend to be propelled by institutional investment, the Chinese market is dominated by retail investors.

Domestic, high net-worth investors initially began moving into the market after losing interest in areas such as property and private equity. The launch of the Shanghai/Hong Kong Stock Connect Scheme, allowing foreign investors direct access to mainland Chinese shares, drove equity demand higher still.

Secondly, I believe the authorities allowed the use of margin finance (borrowing money to buy shares) to spiral out of control. Stereotypical it may be but the Chinese are well-known, prolific gamblers. The regulators were behind the curve in terms of controlling the level of borrowing and their eventual response was disappointing and heavy handed.

As a government that very much likes to control the economy, it has a much harder time in attempting to control the stockmarket. Suspending shares, importing brokers to purchase shares and preventing the shorting of stocks were among some of the measures employed when the market began a steep decline in June this year.

Incidentally, the prevention of shorting was employed by the European authorities during the financial crisis and I am not sure how effective this was at limiting share price falls. In most cases it is mass selling from ordinary investors that cause most damage. On trading suspensions, only two stocks held within Fidelity China Special Situations were suspended and the trading of one has since resumed. The trust’s net asset value was therefore broadly unaffected by the trading suspensions.

Prior to the sell-off, Nicholls increased his short position in A shares listed on the Shanghai and Shenzhen stock exchanges, which are predominantly for domestic investors. This provided an element of shelter in terms of net asset value when the stockmarket fell. He subsequently reduced these short positions and begun adding to his long positions.

The manager feels there are huge valuation dispersions between different areas of the market and is currently finding value in large-cap A-shares. He has also added to a number of smaller companies listed on the Hong Kong Stock Exchange (H shares). These stocks were hit hard when the market fell and he feels they currently represent good value.

Mass-market consumption remains a key investment theme within the portfolio. Take-up remains low in consumer products such as cars and the manager invests in Shanghai Auto and Brilliance in anticipation of increased demand. The internet is another key theme: only 50 per cent of the Chinese population has access to the web compared with over 90 per cent in the west. As internet use rises he expects businesses such as game developer Netease to benefit.

Nicholls is biased to the consumer sector, which remains the largest sector position within the portfolio. This area lagged through the strong market run and he took this opportunity to add to favoured names. Elsewhere, he has reduced exposure to the financial sector, following a period of strong performance.

With the trust’s discount standing at 17.5 per cent, now looks like a good time to invest. For me, there are simply too many bears forecasting China’s downfall and I would bet against the consensus. This is one of my favoured vehicles to do so.

Mark Dampier is head of research at Hargreaves Lansdown.