James Carthew: My China fund is up 60% in six months and has further to go

The chaos created by Trump’s on-again, off-again tariff policies and Musk’s clumsy attempts to slash Federal spending have created an environment where US consumers and companies are wary of making long-term decisions. 

Boycotts of American goods and services are growing and will not go away in a hurry. This is helping to stall the US economy and, when coupled with the unexpected rise of China’s DeepSeek as a rival to US AI companies, has been a trigger for profit taking on US stocks.

In some ways, the rout is not really that extreme. The S&P 500 is back to levels last seen in September 2024 but has still more than doubled over the past five years. The ride for investors in the Magnificent Seven has been a bit rougher over the past few weeks, but relative to the S&P 500, they are just back to where they were in November 2024.

What that means is that, even after the falls, valuations of US stocks still look stretched relative to international peers.

Unsurprisingly, most investment companies are experiencing portfolio net asset value (NAV) and share price falls in this environment. However, there are some pockets of good news, notably in funds exposed to China and Europe, which is ironic given Trump’s aim to make America great again at their expense.

One of my best-performing holdings at the moment is Fidelity China Special Situations (FCSS ). Over six months, its share price is up more than 60%, helped by a narrowing of its discount from 12% to just over 6%. However, as with the S&P 500 index’s fall, if you zoom out a bit, the narrative changes somewhat. The NAV is at the same level that it was in 2018 and remains a long way short of the peak in February 2021. FCSS’s portfolio is trading on just 10 times forward earnings.

Analysts and commentators have been a bit dubious about the long-term benefits of the various stimulus measures that the Chinese government has announced in recent months. My gut feeling is that a key driver of the change in sentiment was DeepSeek and Xi Jinping’s decision to embrace its success by holding a public meeting with the leaders of many of China’s largest technology companies.

The government’s decision to crack down on these companies several years ago – including cancelling the flotation of Ant Group in November 2020 (which hit Alibaba) and curbing video gaming in 2021 (which hit Tencent), coupled with various temporary ‘disappearances’ of CEOs – unnerved foreign investors. This amplified the effects of overlong Covid-related lockdowns and the bursting of a debt-fuelled property bubble on China’s stock market.

Why I’m a fan of Fidelity China

Dale Nicholls has been running FCSS for more than 10 years now. Over the period since he took on responsibility for it at the start of April 2014 up to the end of February 2025, he has produced NAV returns of 211%. That compares to 106% for MSCI China, 114% for JPMorgan China Growth and Income (JCGI ), and a meagre 36% for Baillie Gifford China Growth Trust (BGCG ). Although to be fair, that last trust did not have an all-China mandate until late in 2020 – before that, it was Witan Pacific.

However, over the 12 months that ended on 28 February 2025, all three trusts underperformed the MSCI China Index. FCSS still led the pack, with a NAV return of 36.6%, but this trailed the index by 3.2 percentage points.

One reason that I like FCSS is that it makes good use of the closed-end structure, with meaningful levels of gearing, some unlisted holdings, and the use of short positions on selected stocks.

FCSS also has a big bias toward small-cap stocks. It has exposure to Tencent and Alibaba, but relative to its benchmark (alongside China Construction Bank and Xiaomi) these are among its largest underweights. Generally, the trust is very underweight large caps and overweight companies with a market capitalisation of less than £1bn – 37.2% of the portfolio is in these stocks versus just 0.1% of the benchmark at the end of January 2025.

That small-cap overweight has weighed on FCSS’s returns over the past year – the MSCI China Small Cap Index has underperformed by almost 12% over that period.

FCSS is also heavily overweight consumer discretionary stocks. The government has attempted to stimulate demand for household appliances with deals for people trading in older models. There are also subsidies for purchases of some electronic goods, and there is support for switching to more fuel-efficient cars. However, consumers are still sitting on high cash deposits. Nicholls thinks consumer stocks are cheap and that value will be recognised in time.

China’s sabre-rattling towards its neighbours (not just Taiwan), its treatment of minorities, and increasing autocracy did have me wondering whether I should have any direct China exposure in my portfolio. Nicholls argues, however, that it is too big to ignore. He points out the dichotomy between China accounting for about 17% of world GDP yet less than 3% of global equity portfolios. 

Investors’ fixation on the US creates a bias in the perception of stocks too. A good example is ByteDance, an unlisted company and FCSS’s largest off-benchmark position, where you might think that a possible US ban for TikTok would do irreparable damage to the company. Nicholls points out that TikTok’s US user base is around a tenth of its total. He thinks that the negative headlines are more than reflected in the stock’s valuation and has added to the position.

On a larger scale, the valuation impact of tariffs is probably overdone, too. The Fidelity manager highlights that just 3% of the revenue of constituents of the MSCI China Index is derived from the US. The strength of domestic demand is far more important.

DeepSeek may have come as a surprise to markets, but Nicholls stresses the considerable innovation that is going on in China, with much higher absolute spend on R&D, and many more patents than countries such as the US, Germany, and Japan. FCSS’s portfolio includes companies such as Pony.ai, a leader in self-driving technology, and Hesai, a leader in LIDAR technology which is also important in autonomous vehicles. 

To my mind, it is innovation such as this that could reignite the China growth story. I am sticking with my holding.

James Carthew is head of investment company research at QuotedData

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