So far, precisely one open-ended fund has featured on the site to day: Schroder Asian Income. An odd choice you may think, but the case for Asian, Chinese and even broader emerging market stocks just strikes me as quite strong right now. Granted, you can probably make a case for the S&P 500 based on low interest rates – yes, even at a price-earnings ratio (“PE”) of 23 – and I have done so before. But it is also not hard to make a negative case either. Indeed, a quick look through history would be enough to support the latter point of view. The NASDAQ 100 trading at a PE of nearly 40 does not look particularly inspiring either.
That brings me to China, where value stocks look very attractive at the moment. Obviously there are a number of Chinese equity funds to choose from out there, but not that many with a value tilt. This is where Fidelity China Focus comes in. The fund is reasonably chunky by UK standards – assets equal around £1.8b – and it holds approximately 70 stocks in total. It is also weighted more toward the large-cap end of the spectrum. The top-ten holdings here include the likes of China Mobile, offshore oil producer CNOOC and two of the big four Chinese banks. Tech giants Tencent Holdings and Alibaba Group also feature on the list. Note that the top-ten constitute just over half of the fund’s total assets, so it is pretty top heavy.
The manager makes no bones about this being a value strategy. Indeed, the weighted average PE of the fund’s holdings stands at just 8.9x earnings according to Fidelity. The underlying dividend yield is also well over the 4% mark, while the weighted price-to-book ratio stands at just 0.9. This, on the face of it, is one very cheap set of stocks. I mean, just compare and contrast to the US indices mentioned above. The S&P 500, for example, currently offers a circa 1.5% dividend yield and trades at around 4x book value. A US blue chip value fund in the same mould as this one, while clearly cheaper than the broader index, would not be anywhere near as cheap as Fidelity China Focus.
The above is even more eye-opening in the context of China’s growth. Of course, the idea that the country is now perhaps the main engine of global economic growth is not exactly original. The IMF expects the Chinese economy to grow 8.1% this year, and around 5.5% in 2022. Heck, it even managed to record 2.3% real terms growth in 2020, despite COVID. The nation’s nominal GDP – which currently stands at around $14t – has increased more than tenfold over the past two decades. It is now comfortably the world’s second largest economy as most folks know.
According to the World Bank, Chinese GDP (PPP) per capita clocked in at just $2,900 back in 2000. It has since grown to its current level of around $17,000. The UK, just by way of comparison, sports a GDP (PPP) per capita figure of around $50,000. The comparable figure in the United States is around $65,000. Quick maths puts China at around a third that of the UK and a quarter that of the USA. That ratio is roughly comparable to Singapore and Japan in around 1960 or so. You can guess the investment returns that those two enjoyed over the following few decades. Now, that is not to say that China is a slam dunk in terms of ending up as rich as its developed Asian peers, but it clearly has plenty of room still to grow.
Turning back to Fidelity China Focus, it clearly seems like even more of a bargain when set against the above. Granted, its stocks appear to be quite stodgy relative to the benchmark, but the point stands nonetheless. Fidelity put the average earnings growth of the current constituents at around 7.8% last year. The projected growth rate this year is around 6.5% or so. That is a lot lower than the broader China Equity space, but the valuation discount more than offsets this spread. The fund’s holdings currently trade at less than half the broader category in terms of the PE.
If we flip the portfolio’s PE ratio on its head, it gives us an earnings yield of around 11.2%. The underlying dividend yield currently stands at around 4.4%. The implied payout ratio looks pretty healthy – so plenty of retained profit is being generated in order to fund growth. Now, the fund has returned 12% per annum in GBP terms over the past five years, which is almost four points lower than China Equity as a whole. Value as a strategy has not done great in that time – and I’d guess high flying growth stocks may explain most of the performance gap. Note also the ongoing change stands at a chunky 1.06% – obviously higher than most would like, but there aren’t many options, and certainly not in the lower-cost passive space.
Underperformance looks even worse on more recent one-year and three-year horizons, almost certainly for the same reason as above. I don’t mind that at all and I hope the manager sticks to their guns and isn’t tempted to switch strategy. Going forward, this will not present much of an issue for those with longer-term horizons, and the fund should do very well indeed assuming the Chinese economy keeps on growing at a high single-digit annual clip.
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