Many investors are making a big mistake by looking at China from a Western perspective, according to investment legend Anthony Bolton.
After his first retirement, the veteran fund manager was enticed back into the game in 2010 by the prospect of investing in China.
The result was mixed, with the Fidelity China Special Situations fund starting well. The share price peaked at 126p in October 2010 before slump-ing to almost 70p 18 months after launch.
The fund has improved significantly since then, with a net asset value almost 20 per cent greater than at launch and a share price just above where it started four years ago.
Bolton stepped down again on 1 April to become a consultant and a director of Fidelity Worldwide Investments.
Frame of reference
Speaking at a press briefing in London last week, Bolton said he believes China requires its own frame of reference and he remains convinced about the market’s good prospects. He said: “One of the mistakes about China is to look at it from a Western perspective.”
He said the common Western fears about investing in China are the same as those put forward four years ago when he started the fund. He rejected comparisons between the Chinese financial sector now
and the US at the height of the credit bubble. He said: “People are talking about there being a kind of Lehman Brothers moment. That is extremely unlikely.”
Bolton pointed out that while China’s debt is large at more than 200 per cent of GDP, its savings ratio remains high and the debt relates to investment rather than consumption. He noted the investment vehicles created by local government to ramp up infrastructure investment, which have resulted in councils taking on a lot of short-term credit.
While he feels this was a poor strat-egy, Bolton said that “over time, as the bond market develops, I think that mismatch is going to go away”.
Morningstar’s Matthews Asia res-earch team says pinning down the country’s total debt is difficult. Esti-mates of the public sector’s share range from 45 per cent to 85 per cent of GDP, which includes central and local government, banks and state-owned enterprises.
The team says that while China’s shadow banking sector is opaque, it is not outsized compared with other countries and in fact prices risk better than the poorly performing, centrally controlled finance sector.
Morningstar says: “As China’s economy evolves, it would benefit from a more balanced financial arch-itecture. This includes further development of its $4tn [£2.41tn] bond market and of a robust market for asset-backed securities and securitised debt so as to more efficiently clear bank balance sheets of unwanted loans and create high-yield fixed-income securities for investors.”
It adds that while China’s debt needs to be addressed, its current account surplus, self-funded banking system and moderate credit-to-deposit ratios make that task easier.
Bolton said the reform programme announced at the Third Plenum last year is “key” to unleashing the potential of China. He explained that over the medium term, private companies will outperform because state-owned enterprises have other priorities than profit. For that reason he advises against index exposure as returns will be dragged down by inefficient publicly owned giants.
Role of research
Bolton warned that research is paramount – a lesson he learned in 2011 when he had to swallow massive losses and sell out of several Chinese companies listed in the US that were subsequently accused of fraud.
“Corporate governance is a euph-emism for ‘Are the figures real and are the management lying to me?’ The Chinese are great liars,” he said.
When Fidelity investigated a Chinese IPO that claimed in its prospectus to own 1,000 stores, the research team found that only 500 existed.
“That was something you expected the prospectus to get right. To be wrong by 50 per cent – that was a bit of an eye-opener.”
Bolton does not believe China will hit its official growth target of 7.5 per cent this year due to a slowdown in the state’s appetite for more investment stimulus. He envisages growth of 6.5 per cent.
His successor, Dale Nicholls, has worked as deputy manager under Bolton since June 2013 and shares his views on the sectors with the most promise: consumption, IT and healthcare (see box above).
Bolton acknowledged his fund’s performance had been “disappointing” and noted that the two years in the middle of his tenure had experienced the most difficult conditions of more than 30 years spent running money. “I am happy to admit I was wrong about the market,” he said. I thought it would go up over four years; instead it went down.
I had a fund where the tide has been against me, and it is a geared fund too.”
But Bolton said his conviction about the “new China” is starting to bear fruit. “I hope that has vindicated me but I would have loved to see a better share price when I left.
“I hope I have lined it up for Dale Nicholls over the next few years.”
We used Bolton’s UK special situations back in the day, but we did not buy in to the China fund – and obviously that kind of worked out quite well.
China is a powerhouse of the world. But it only accounts for about 3 per cent of the world’s stock markets by value despite being the world’s second largest economy, which is staggering.
Paul Greaves is chartered financial planner at Hart Greaves
The New China
Bolton sees private companies as the ‘new China’ and has angled the Fidelity China Special Situations portfolio to take advantage.
The three key overweights for the fund are:
- Consumption: Although a state-owned enterprise, SAIC Motor Corporation has 20 per cent market share and joint ventures with Volkswagen and General Motors. It makes up 2.1 per cent of the fund.
- Healthcare: The pharmaceutical and consumer healthcare firm Hutchinson China Meditech accounts for 2.4 per cent of the portfolio. Its price has soared 45 per cent in the past six months.
- IT: Investment company Tencent Holdings is the fourth largest internet company worldwide after Google, Amazon and Ebay, and is valued at more than $100bn . It has an instant messenger service, social networks online games and other technology holdings. It is the fund’s largest holding, at 5.5 per cent.