A near record high weighting to China and Hong Kong dragged Fidelity Asian Values (FAS ) behind its benchmark but ever the contrarian, fund manager Nitin Bajaj is holding firm and waiting for its Chinese small-cap stocks to rerate.

The £359m portfolio of undervalued Asian smaller companies struggled in the six months to end of January 2024, with the net asset value (NAV) total returns sliding 2.4% and the shares losing 2.5%, lagging the MSCI All Countries ex Japan Small Cap index which rose 3.6% over the same period.

Bajaj’s contrarian approach saw him take the combined exposure to China and Hong Kong close to a historic high of 40.6%, far higher than the 13% averaged by the index. However, the small-cap index in China and Hong Kong fell 28.2% and 18.4%, respectively.

The detractors were Chinese consumer-related companies such as China Yongda Automobile Services, automotive retail and services group Zhongsheng, and Focus Media Information Technology. Real estate also caused an issue as China faced the collapse of its property market, with China Overseas Grand Oceans Group falling on ‘weak demand and negative investor sentiment’.

The China and Hong Kong exposure at the end of February stood at 39.3%, a level Bajaj said he was ‘comfortable’ with.

‘We continue to have an overweight exposure to China since we are finding a significant margin of safety in owning several well-financed and well-run businesses,’ he said.

‘As the world’s second largest economy, where consumption is expanding as a share of GDP, we believe that both earnings and multiples of our Chinese holdings will re-rate favourably from depressed levels.’

Bajaj has pushed his exposure to India to a historical low despite four out of five of the top contributors being Indian small-caps. Power trading company PTC India, mortgage financier LIC Housing Finance, pharmaceuticals manufacturer Granules India, and Axis Bank made up the top five with Bank Negara Indonesia.

While Bajaj is still positive on the companies, he trimmed exposure to PTC India and Granules India ‘as a result of strong performance and a reduced margin of safety’.

He said Indian smaller companies are ‘now 40% more expensive than Asian small-caps and 30% more expensive than Indian large caps’.

Bajaj is still interested in ‘well-run financial companies’ that are attractively valued in both India and Indonesia.

‘These are good long-term compounders as credit is underpenetrated and the well managed banks have significant industry tailwinds,’ he said.

‘Meanwhile, we continue to avoid areas that most investors find fashionable, such as artificial intelligence (AI)-driven technology hardware in Taiwan and Korea.’

This sector has seen a boom in capex spending post-Covid as demand soared but Bajaj said he was seeing ‘earnings downgrades as new supplies come in and demand falls back, as the AI hype subsides’.

‘This strategy has served us well in the past 10 years and we believe it will continue to reward us well over the future,’ he said.

In its AIC Asia Pacific Smaller Company sector, which comprises FAS, Abrdn Asia Focus (AAS ), and Scottish Oriental Smaller Companies (SST ), performance has lagged over one year with the NAV up just 9.1% versus a 12.7% average. Over three years, Bajaj has failed to beat the average, up 25.7% against 27.5%, but is slightly ahead over five years, delivering 48% NAV returns against 48.7% from AAS and 44.2% from SST.