Summary: Fidelity Asia portfolio manager Anthony Srom is underweight China, concerned that investors are pinning hopes on government stimulus and not factoring in the risks. Although he says there are interesting pockets of the Chinese market, he points out that return on capital in India is higher. The fund is holding slightly more cash than normal as markets rally.
Key take-out: Srom takes the view that the Chinese government has lost control of the economy, as stimulus is not getting traction. Although the index has rallied, performance has come from multiple expansion.
Key beneficiaries: International investors. Category: International investing.
China’s main share market has emerged from its slumber in spectacular fashion and has rallied more than a mind blowing 130 per cent over the past year. A number so great it has many investors questioning if it is at all sustainable, or what will befall the market.
Fidelity Asia portfolio manager Anthony Srom is indeed worried about the Chinese market. Consequently the fund only carries a 50 per cent exposure to China-listed shares compared to the benchmark, taking a significant relative underweight position. Despite the problems facing one country, Srom feels there is plenty of value to be found throughout Asia.
For investors, the question of whether to invest internationally or not comes down to their belief of what the Australian market can deliver. The Asian story is compelling, especially the opportunity for growth, but it’s not without risks.
KS: China has the attention of investors at the moment. Can you explain what’s happening?
AS: If you wind back the clock to the second half of last year, most of the market would have been consensus underweight to China. Government policy was aimed at stimulating the China A share market and consequently it started to take off. Then people realised, if you’re more benchmark aware it’s not a great position to be underweight China so they started closing that and as a result you have seen a significant flow of funds go into the China market.
There is now a divergence between Chinese investors and foreign investors. If you look at foreign investors, they have been net sellers of Chinese equities so they are reducing their exposure to the market. But the retail investors are piling in like there is no tomorrow. There is a bit of moral hazard in that – as long as the government endorses the market the retail investors don’t think they can lose. So you have a difference between the way foreign investors and domestic investors are looking at China.
Does that mean the whole market is overvalued?
There are some interesting pockets of the Chinese market where stocks have reasonable valuations, good return on capital and good growth prospects. Which is more looking at the way a western investor would look at it. But domestic investors look to what’s the hottest now – strong growth so it comes down to technology and biotechnology. Domestic investors are more thematic, looking for popular stocks so valuations take a back seat. We have good stocks in China that are in the fund, but the way the China market is going is a little bit of a concern to me. Compared to the benchmark, China is our biggest relative underweight.
Why does China worry you?
People are pinning a lot of hopes on government stimulus and policy and not factoring in the risks. If you take a top down view, I think the government in China has lost control of the economy. If you wind back the clock 2, 3, 4 years ago, the government pushed a button and the economy responded. Now, the economy is not responding and they are trying to push a button, but it’s not working. The reserve requirement ratio (RRR) cuts, interest rate cuts and government stimulus have not got any type of traction at all.
It’s the frequency and magnitude of these RRR and interest cuts that indicates to me the government is panicking. It’s not working. Looking at it from a macro perspective, the stock market leads the economy by about six months. China started rallying in July of last year, and we have seen no economic traction whatsoever since.
Let’s talk MSCI China, it has rallied a lot. But if you look at performance, it has come from multiple expansion. So what I’m saying, the EPS is lower than what it was 12 months ago, but the market is higher. You’ve generated 100 per cent of your return from a re-rating in the PE multiple. That is what worries about me with China from a macro perspective because the economy isn’t responding to all these measures the government is trying to implement.
Where can you find better value in Asia?
Return on capital from the Indian market is about 40 per cent higher than what you are getting from China. So to me, paying a couple of PE points for India, for better quality management teams, better quality franchises and much higher return on capital tends to make more sense. I feel there are better higher conviction opportunities in India than in China.
The fund doesn’t have any hedging.
In order for the hedging to be done properly you have to take a currency view as well. As a firm, we aren’t a currency house. So we would be making a call in something we don’t have expertise on. We can do it, but really it’s very much a business decision. It’s about stock picking, which is something within our hands and hopefully we can make a good decision based on that.
There’s 10 per cent cash in the fund at the moment, is this more than normal?
Yes, it’s above historical averages. The normal cash position is between 3 and 6 per cent. I tend to find as a manager, generally as markets rally the cash lifts a little bit as buying good companies at reasonable prices gets harder to do. It’s a function of markets as well and where valuations are generally.
What about information technology? You are relatively underweight compared to the benchmark.
In terms of IT, it’s a combination of things. When you look at most of the technology sector in Asia it’s either overvalued, or the companies are just lower quality, short cycle type businesses. And when you think about the companies exposed to the Apple supply chain in Asia, it has worked well, but how much more legs do you have in the Apple iPhone thematic? Taking a one to two year view, does it really get much better? I struggle with that and valuation doesn’t look that attractive. Technology changes very fast, and the risks are high. The companies aren’t priced for it, or they are lower quality tech companies so as a default we are underweight technology in Asia.
Kirstie Spicer is content director at brightday.