Fidelity China Special Situations (LON:FCSS) Portfolio Manager Dale Nicholls caught up with DirectorsTalk for a quick-fire interview and his thoughts on investing in China and China-focused UK fund, FCSS.
Why do you think now is a good time to invest in China?
I think it’s actually good timing to be looking at investing in China. Things are cheap and there’s a lot of opportunity. In addition, sentiment has notably improved after the Deepseek announcement, and we’ve seen some inflows into Chinese equities as a result. However, investors are still lowly allocated to the country compared to benchmarks and past allocations.
2. What key factors do you consider when selecting investments?
One is scale—thinking about how big a company can be in 5, 10, or 15 years. Second is returns—incremental returns on capital and competitive advantage. Third is management—ensuring they can execute on the opportunity. And finally, tomorrow’s gems—we prefer to identify mid to small-cap companies with the potential to graduate into mid and large caps over time.
3. How do you view China’s GDP growth and economic outlook?
China has taken a different approach compared to many Western economies post-COVID. Growth has been relatively tepid, but we’re still talking about 5%. In a global context, that’s not particularly bad. Consumer confidence has been weak, largely due to employment concerns and property sector challenges, but we see signs of stabilisation, and I think the outlook is improving.
4. What could be the catalyst for a change in sentiment towards China?
I think it’s gradual improvement. Property prices stabilising, consumption numbers slowly getting better—then the market starts to realise that there’s a lot of potential upside given the state of the consumer. It’s just about stabilisation and improvement. Companies are still growing earnings, and a lot of the risks are already priced in.
5. What is your perspective on the impact of tariffs and geopolitics on Chinese companies?
Tariffs have been very well flagged. Many Chinese companies are already paying 25% tax from the first Trump administration, so they’ve adapted. What’s interesting is that many of the companies we look at have actually gained market share despite these tariffs and are making higher margins internationally than domestically. The MSCI China index has less than 3% US revenue exposure, so the impact is often overstated.
6. How are institutional investors currently positioning themselves in China?
A lot of foreign money has already come out. Domestically, the mutual fund industry remains strong, savings continue to grow, and insurance assets are expanding. I think institutional domestic ownership will continue to grow, while international investors could return as sentiment stabilises.
7. How do you manage the discount to NAV for Fidelity China Special Situations?
Our policy is targeting a single-digit discount. The main tool we use is share buybacks. Last year, we bought back just over 4% of outstanding shares, and given the current discount, we’re being pretty active again this year.
8. What excites you most about investing in China?
It’s the opportunity—seeing great companies trading at great valuations, not being appreciated by the market, and imagining how things could look in six or twelve months with just a small shift in sentiment. I love looking at individual companies and following their execution.
9. Do you visit your portfolio companies in China?
Absolutely, I visit our portfolio companies all the time. In addition, the board comes to China every year to visit key holdings, and I think on the last trip, they came out the most bullish they’ve ever been. If you’re just reading headlines in the FT every day, you’ll get a negative view, but when you’re on the ground, meeting companies, and understanding how they’re managing challenges, it’s actually pretty exciting.
10. How do you approach investing in private versus state-owned enterprises (SOEs) in China?
The vast majority of our holdings are in privately owned listed companies. In general, we find that privately owned listed companies are where we’re much more aligned with the management team. We don’t exclude SOEs—there can be good value in some of them—but privately owned listed companies tend to be our main focus.
12. How do you see China’s consumer sector evolving?
The consumer sector has been weak, but I think it’s an area presenting a lot of value. Consumer confidence has been hit by job cuts in big tech and the downturn in property, but consumers are cashed up—savings are up, debt is down. If confidence stabilises, we could see a strong recovery in spending.
13. What is your view on China’s innovation and technological development?
China is highly innovative, and that’s sometimes underappreciated. Nearly 50% of global patent filings now come from China. Private companies have compounded R&D spend at about 20% per year over the last decade, which is driving increased competitiveness. We see entire industries emerging—electric vehicles (EVs) are a great example, where China now dominates globally.
14. How has China’s electric vehicle (EV) industry evolved?
China has gone from being number five to number one in auto exports in the last three years. Over 60% of the world’s EVs are produced in China. The sheer volume of production in the domestic market has given Chinese EV makers a significant competitive advantage globally.
15. How do you assess the valuation of Chinese stocks compared to other markets?
China is trading at around 9 to 10 times forward earnings, roughly one standard deviation below historical averages. That’s about a 60% discount to the US, even though forward earnings growth for MSCI China is around 10%. Much of the earnings downgrades have come from property, whereas sectors like technology have actually seen upgrades.
16. What are your thoughts on share buybacks and dividend trends in China?
For the first time last year, China was reducing overall share count due to increased buybacks and dividends. Many of our portfolio companies are returning capital to shareholders, with some offering double-digit yields when combining buybacks and dividends. The payout ratio trend is similar to what we saw in Japan before that market turned positive. These increased shareholder returns has helped the Trust maintain its record of growing dividends.
17. How does your investment strategy leverage your team in China?
We have 17 analysts with dedicated China coverage, based in Hong Kong and Shanghai. Their job is to identify the best opportunities in their sectors and bring them into the portfolio. I talk to them every day, and they are a key part of our ability to find early-stage companies with long-term growth potential.
18. What impact has China’s property sector had on the economy and your investment outlook?
We’ve seen a significant policy shift since September last year, moving towards easing. There are early signs of stabilisation in home prices in tier-one cities, which could support consumer confidence going forward.
19. What is your view on the impact of US-China relations on Chinese investments?
Geopolitics is always a risk, and tariffs are a frequent discussion point. However, most Chinese companies have already adapted, and many continue to gain market share internationally despite these challenges. The vast majority of companies in MSCI China are domestically focused, and US revenue exposure in our benchmark is under 3%.
20. How do you view China’s position in the global economy in relation to its weight in global benchmarks?
China represents around 17% of global GDP but only 3% of global investment benchmarks. Investors are actually underweight even relative to that small representation. If sentiment improves, there is significant potential for capital inflows, given how underrepresented China is in global portfolios.
Fidelity China Special Situations PLC (LON:FCSS), the UK’s largest China Investment Trust, capitalises on Fidelity’s extensive, locally-based analyst team to find attractive opportunities in a market too big to ignore. It invests in the public equity markets of China.
