Fidelity China Special Situations plc (LON:FCSS) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: You called your report on Fidelity China Special Situations, “Eight questions for the 20 July AGM”? What is your brief summary of it?
A1: In this note, we explored what investors could ask the Fidelity China board at the forthcoming 20 July AGM, and we provided the answers we would give if asked those questions ourselves.
We identified three key themes: i) COVID-19; ii) regulation; and iii) geopolitical tension. All were explored in detail in our initiation.
While China managed the initial stages of COVID-19 well, its recent lockdowns have raised concerns about growth. Understanding why regulations were introduced means investors can identify companies at risk and when the restrictions will end. Geopolitical tension, while hard to assess, is at above normal levels, but this is not a new risk. Market-wide pricing moves create opportunities.
Q2: So what was your answer to the question about COVID-19 and the impact on growth?
A2: There are both direct effects on weaker consumption, and the knock-on effects of disrupted supply chains and logistical bottlenecks. The economy was already under pressure from a weak property market. Before becoming too pessimistic, however, it is worth bearing in mind that many commentators appear to have focused on the lockdown and have given relatively little attention to what the government may do about the problem.
Our experience is that markets frequently underestimate the impact of policy responses to crises until such responses have been announced. This was certainly the case for Western markets in the early stages of COVID-19. Even though governments do react to crises, markets do not always give them credit in advance for doing so. To date, the initiatives have, in our view, been tinkering around the edges, because the scale of the problem has been unknown.
The underlying fact is that China is a state-controlled economy, and that the state has significant financial levers to manage the economy and deliver stimulus quickly and effectively if it feels the need to do so.
Q3: And what about regulatory risk?
A3: Understanding why the regulations are changing helps appreciate where future risks may lie. We have identified three key themes, each of which will have a dramatically different impact on specific stocks: i) concerns about social inequality; ii) data protection and national security; and iii) threats to the Communist Party control if they thought money and power could be concentrated in just a few private or overseas hands.
The latter is why, in our view, there were the attacks on the huge tech companies. Now, going forward, China needs strong growth to ensure social cohesion and a smooth transition from a rural to a modern, urban society. This requires a dynamic market, freedom, economic vibrancy and liberation, especially in smaller and middle markets. We believe the recent liberal announcements reflect this balancing act between these conflicting ambitions and, for a while, regulatory risk may be below-average.
Q4: And what about geopolitical risk?
A4: We believe that geopolitical tension is nothing new in the relationship between global superpowers. The conflict in Ukraine has added a new, potentially, very serious dimension, but it also just adds to an already long list, including Hong Kong, trade deficit, intellectual property, Uyghur and human rights. We expect geopolitical tension to ebb and flow; at present, it is above normal, but tension will be part of the normal course of business over the long term.
Looking at some of FCSS’s share price reactions, or rather non-reactions to specific events in the past, we note that the Hang Seng rose by 30% in the 10 months after the 1991 Gulf War, having fallen 20% in the initial uncertainty around it.
Q5: And, finally, you highlighted that these risks also create opportunities?
A5: Market-wide dislocations create stock-specific pricing anomalies. If all share prices fall, the companies that are not affecting the risks are mis-priced.
Deep, fundamental research by a long-established, large, local team gives Fidelity China Special Situations a competitive advantage over global players, while access to Fidelity’s global analysts and the manager’s regional experience give a perspective unavailable to domestic peers. Its competitive advantage increases with the number of opportunities. Fidelity, as a geared player, is likely to see more volatility, to both the upside and downside.
