Fidelity China Special Situations (FCSS ) fund manager Dale Nicholls has said the Chinese government’s small ‘golden share’ stakes in technology companies are a good thing because their managements shouldn’t fall foul of future regulation.

Speaking to journalists at Fidelity’s London office, Nicholls said the Chinese Communist Party’s 1% stakes in some of the country’s largest companies, including Alibaba and Tencent, would help them steer away from potential pitfalls, such as 2021’s crackdown on the tech sector. 

Nicholls pointed out that government officials tend to sit on the boards of sub-companies within the larger group, rather than on the main board, and their presence did not warrant increased caution from investors.

In China, they are known as ‘special management shares’ and have become a tool the state uses to exert influence over companies. Last year, Communist party official Wu Shugang was appointed to the board of TikTok owner ByteDance, for example.

While regulation is one reason for investor caution to China, Hong Kong-based Nicholls said that after the technology intervention wiped off a reported $1.1tn (£888bn) from the sector, the CCP was more concerned with allowing the ailing economy to recover.

‘[Domestic regulation] is somewhat cyclical. Obviously, the last couple of years were probably the toughest and longest negative regulatory period, but that’s definitely peaked. Now the focus we find when we listen to government speeches is much more on growth and that’s no surprise given what’s happening with the economy,’ Nichollas (pictured) said.

Data this week showed China’s economy grew 5.3% year-on-year in the first quarter, beating the consensus forecast of 4.6% and the 5.2% growth for the whole of last year.

While the sharp downturn in property continues to weigh, Nicholls anticipated more government actions would stimulate activity, while consumer confidence and manufacturing headed in the right direction.  

In the past year, the manager has found some success with smaller consumer discretionary stocks. Shares in Hisense Home Appliances, which produces fridges and air conditioners, have almost doubled, he said.

Nicholls has several ‘short’ positions in car manufacturers, whose shares he expects to fall given the increasing competition in the sector.

Opportune merger

The trust’s recent merger with Abrdn China was timely, given the bulk of the £127m of assets were in cash at the time of the transaction that Nicholls could invest at the current low valuations, he said.

China continues to trade at a huge discount to the bouyant US stock market. Fidelity data shows that in terms of 12-month forward price to earnings, the vauation of the MSCI China index trailed nearly 60% below the S&P 500 index at 31 March. This is the widest gap in about 10 years, bar a brief period in mid-2022.

The Australian, who is celebrating ten years running the £1bn trust, said he hadn’t been so positive about China from a risk-reward perspective in some time. He pointed out that while valuations were unlikely to return to the ‘heady days’, the strong GDP growth figure provided a good backdrop for businesses to narrow the discount to global markets.

Not only that, but in an echo of governance reform in Japan, the Chinese government has also encouraged companies to return cash to investors via share buybacks and dividends, particularly if they had issued equity when their stock previously traded at a premium.

This is particularly notable in the internet sector, with ecommerce company Alibaba and media business Tencent respectively yielding 7.6% and 4.5%.

‘I think there’s a bit of a mindset that if we’re not going to get paid by the market, we’d like to get paid by the companies, so we’re definitely making that argument to companies as well,’ he said.

Decade of two halves

Since Nicholls took over from Anthony Bolton, the trust’s first fund manager, in April 2014, the portfolio of China A-shares, US and Hong Kong-listed Chinese companies as well as private mainland companies had delivered shareholder returns of 129%, almost treble the MSCI China index’s 56%.

The underlying growth in net asset value (NAV) achieved by Nicholls has been 137%, according to Morningstar data. The gap between the two is explained by the shares trading 10% below asset value, which the board has responded to by buying back 4% of the stock in the past year to prevent the discount widening further. 

Over five years, however,  shareholders have lost 9%, although that is much better than the benchmark’s 26% slump and beats its two other listed fund rivals from JPMorgan (JCGI ) and Baillie Gifford (BGCG ).