FOCUS: Fidelity Asia

Fidelity’s locally-based Asian equities team discuss the next chapter of the region’s growth story

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Like all emerging markets, Asia is not immune from periods of heightened volatility and swings in sentiment. While this naturally warrants a certain risk tolerance, the opportunities being created by the region’s long-term structural growth story remain significant. With valuations also attractive - particularly relative to some developed markets - could now be an opportune time to increase or initiate exposure to Asian equities? In this guide, we review how Fidelity’s Asia range offers a different and distinct way of accessing an exciting region Portfolio Managers Teera Chanpongsang, Jochen Breuer and Hyomi Jie give their market views and discuss how their portfolios take an active, bottom-up approach which maximises the group’s research-led philosophy and seeks to deliver consistent client returns.

Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Fidelity’s range of Asian equity funds have the potential of having high volatility either from their composition or the techniques used to manage them. The funds can use financial derivatives which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Investments in small and emerging markets can be more volatile than other more developed markets. Changes in currency exchange rates may affect the value of investments in overseas markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Investments in Fidelity funds should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document, current annual and semi-annual reports free of charge on request by calling 0800 368 1732. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority and Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. UKM0419/23974/SSO/NA

Over the last 20 years, China’s weighting in the MSCI Asia ex Japan Index has increased from less than 1% in 1999 to around 37% now. This is set to rise further when the MSCI scales up the A-share inclusion by the end of 2019. The rising representation of China in broader Asian indices is an acknowledgment of the size and importance of China’s economy for this region. It also indicates the structural shifts taking place within China: today a variety of companies are listing in Hong Kong and the US, besides domestic stock markets. The stock market is reflecting what is unfolding at ‘ground level’. For instance, domestic consumption opportunities have changed from investing in department stores and supermarkets to investing in e-commerce, social networking apps, gaming and so on. The listing of Alibaba, the flagship Chinese ecommerce company, in 2014 and its subsequent growth as a stock market giant is emblematic of this. Nonetheless, sound investment ideas come from consistently monitoring changes that are unfolding in consumer behaviour, new business models, and even new industries that are emerging. The structural shift that is underway in Asia has a long runway of growth even now and there are a host of opportunities to be discovered.

The outlook for Asia

Changing Asia: How dynamic Asian economies continue to lead global growth

Teera Chanpongsang, Portfolio Manager, Fidelity Asia Fund

Asian equities: how has the investable universe changed over the last 20 years?

Yes, there is rising awareness about the need for higher corporate governance standards in the region, particularly as institutional participation in regional stock markets increases, but the pace of change is not uniform in Asia. Fidelity has played a big part in active engagements and shareholder voting to create positive change. Encouragingly, we find companies are becoming more open to corporate governance related engagements and receptive to discussing proposals for improvement.

Corporate governance standards in much of Asia remain lower than in more developed economies, according to the Asia Corporate Governance Association. Are improvements on the horizon?

I believe that the best way to understand risk is to understand the company I’m investing in, its industry and the countries it operates in through on-the-ground research. I focus my risk control on stock selection and ensuring the robustness of individual investment theses in the fund. I believe that the most effective way of mitigating external risks to any business is to assess the experience, responsiveness and resilience of management teams that are responsible for the businesses the fund invests in.

What key areas of risk have you identified in the region and how are you mitigating them?

The fund aims for consistent alpha generation based on a clear investment philosophy that has been tested across a variety of market environments. The strategy is to identify high quality stocks with robust business models and strong management teams, where the current stock price does not reflect these fundamentals. I am then looking to hold these positions over the long-term to offer structural growth from Asian economies and outperform the benchmark. To achieve this, I rely on my deep experience in these markets, in addition to Fidelity’s extensive proprietary research capabilities.

You manage the Fidelity Asia Fund. What is it designed to do?

I am a bottom-up stock picker and I use a mosaic approach to investing, where I search for companies with a potential for sustainable growth that trade below intrinsic value as mentioned above. This can take the form of improving fundamentals not reflected in the price, growth potential not fully understood, restructuring and turnaround opportunities, and cyclical turns in certain industries. I am sensitive to valuation and will not pay any price for growth. Meeting companies and in-depth discussions with Fidelity’s in-house analysts form the basis of my investment decisions. I emphasise company visits to assess profitability, the attractiveness of a business, the track record, suitability of the management structure and the level of returns given to shareholders. This underpins my conviction in stocks and helps build the portfolio with high-quality opportunities in the Asian markets.

Can you discuss the fund’s approach and investment style?

Asian companies, driven by a combination of investor demand, regulatory change and more disciplined capital allocation by companies as they mature. Whilst growth is still a key goal for Asian companies, management are rewarding shareholders via increasing dividends and buybacks. This is generally supported by a more progressive regulatory environment. For example, in China we are generally seeing improving dividend pay-outs, especially by the state-owned enterprises. Another example is in Korea, where companies face tax penalties for sitting on too much cash and tax incentives for putting this cash to work for shareholders. As a result, we have seen superior dividend growth in Asia versus other markets in recent years.

Asia’s emerging dividend story

Over the last few years we have seen significant dividend policy developments for Asian companies

Jochen Breuer, Portfolio Manager, Fidelity Asian Dividend Fund

Lessons from 1997

Crucially, dividends are supported by strong balance sheets, which can be traced back to the 1997 Asia financial crisis. During this period companies learned a hard lesson in what happens if you do not allocate capital correctly and borrow for domestic ventures in foreign currency. Consequently, Asian companies now enjoy some of the most solid and stable balance sheets in the world, creating a strong foundation for dividend pay-outs. The Fidelity Asian Dividend Fund aims to provide investors with a dividend-based total return, whereby they enjoy capital growth driven by the attractive structural investment opportunities in Asia, but via some of the region’s most sound companies with developed capital allocation policies. As a result, investors should expect lower volatility and drawdown relative to the broader market. The fund also aims to provide investors with an attractive yield and an underlying dividend that grows above the rate of inflation. We concentrate the portfolio into approximately 40 names and construct it with no reference to an underlying index. I aim to hold position sizes of 1% - 5% based on factors such as downside risk, company fundamentals, liquidity and dividends. All of this is managed with a strict valuation framework that looks to widen the margin of safety for the underlying holdings in the portfolio. Ultimately, I see my role as portfolio manager in three parts: stock picker, risk manager and income generator.

sia has typically been viewed as an investment destination for those seeking growth and willing to accept higher bouts of volatility. Over the last few years we have seen significant dividend policy developments for

Heritage in Asia

Need to know

Fidelity’s research footprint across the region

in Asia Pacific ex Japan AUM

£46bn

QFII quota, amongst the highest allocated to a foreign buy-side asset manager

£921m

companies under research coverage in Asia

1,499

equity research analysts in Asia Pacific ex Japan

Asian regional manager by equity AUM*

China offshore manager by equity AUM*

years of doing business in Asia

Source: Fidelity International. 31 March 2019, Assets quoted include Assets under Administration. AMAC = Asset Management Association of China; WFOE = Wholly Foreign Owned Enterprise; *Broadridge (formerly Lipper) 31 August 2018, data includes active funds only; China Equity funds are those listed in Broadridge sector equities Greater China. Includes funds from all domiciles that Broadridge cover which currently excludes US but does include some Asian domiciled funds. AUM and QFII quota figures calculated in GBP based on exchange rates as at 29 March.

Delhi 13 Research Specialists

Mumbai 1 Portfolio Manager 8 Research Professionals

Singapore 9 Portfolio Managers 10 Research Professionals 2 Shorting Analysts

Sydney 5 Portfolio Managers 9 Research Professionals 1 Technical Analyst

Dalian 14 Research Specialists

Tokyo 9 Portfolio Managers 13 Research Professionals

Shanghai 1 Portfolio Manager 4 Research Professionals 1 Trader

Taiwan 3 Portfolio Managers

Hong Kong 11 Portfolio Managers 13 Research Professionals 1 Derivatives Analyst 10 Traders

Source: Fidelity International, 31 March 2019. Data is un-audited. Research professionals include equity analysts and associates.

Strategies to access Asia

fund snapshot

Past performance is not a guide to the future. Source: Morningstar, 31 March 2019. Basis: bid-bid, income reinvested in GBP. The funds’ primary share class according to the IA is shown. Holdings can vary from those in the index quoted. For this reason the comparison index is used for reference only. All OCFs are estimated for the W GBP share classes and actual expenses may be higher in the future. These figures may also vary from year to year.

For more information on Fidelity’s fund range please visit professionals.fidelity.co.uk

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Discrete 5yr period performance overview

City lights

When people become wealthier, the things they want to own, eat and experience change. I don’t think it’s a three or five year story. It’s a decades-long story

Hyomi Jie, Portfolio Manager, Fidelity China Consumer Fund

THE View from China

Cashless Society: Many rely on Alibaba’s Alipay or Tencent’s WeChat mobile payment apps

Alex Illingworth After graduating from Durham, Alex began his career in 1997 running global funds at Rothschild Asset Management. Here, as part of a 3 person fund management team he had responsibility for global long-only and absolute return funds. He also had sole responsibility for 3 ethical and environmental mandates which he ran for 7 years. In 2003 he was appointed a director of global equity at Insight Investment, responsible for long-only, ethical and absolute return funds. He joined Artemis in 2011. Rosanna Burcheri After graduating in economics from Bocconi University in 1996, she joined Paribas Asset Management as a junior fund manager. In 2000, she moved to M&G as a fund manager and director responsible for pan-European equity portfolios. As a senior European portfolio manager at Shell Pension Management Service from 2004, she controlled £710m of assets. Then, in 2006, Rosanna became a partner and pan-European fund manager for FrontPoint Management (UK). She joined Artemis in 2011.

China has been urbanising slowly and steadily over the years, from 35% urbanisation 20 years ago to 60% today and more than 80% expected in the next 20 years, which would put it on par with the US and UK. “When people move to towns and cities their consumption habits change. Eating out, going to the cinema, visiting the shopping mall become the norm and this also leads to ‘premiumisation’ as people become more brand aware”. Government policies are making it easier for people to move to cities, while there is the allure of jobs and access to education. Hyomi suggests that consumption behaviour in China’s Tier 1 cities like Shenzhen and Shanghai is more closely aligned to global international cities like London and New York. With the influence of social media those living in lower tier Chinese cities are becoming increasingly aspirational, further changing consumer tastes. “Urbanisation and social media is leading to a cascade effect of consumption behaviour and this has a large potential benefit for consumer-related companies”.

Market tension

Consumer debt is rising, however, and this remains a risk factor to watch as it could impact household spending. The bigger picture is that China as a whole is highly indebted, with combined household, government and corporate debt running at almost three times GDP. State-owned enterprises are one of the drivers of China’s high debt, while the shadow banking sector has also been a problem area, but credit here declined 10% year-on-year in March while everything else increased by 11%. “Chinese policymakers are well aware of the leverage level but we are seeing progress. The government is leading a change of the debt structure, through things like opening-up the bond market and clamping down on shadow banking. Whilst the amount of debt looks scary, the quality of debt is ok and improving,” says Hyomi. The other issue making headlines is the trade dispute between the US and China and the threat of tariffs on Chinese exports. Hyomi says the situation has stabilised, but the underlying reasons for the US’ stance, such as China’s pace of innovation, government support for globally strategic industries and China’s growing international influence, remain. She predicts underlying tensions are here to stay long-term as the two nations vie to be the world’s most powerful economy and the US may further use the threat of tariffs as a negotiating tool. “However, China’s pace of technological innovation will be hard to stop,” says Hyomi.

Sectors driving growth

The partnership of consumption and technology is a strong theme in the portfolio. Platforms like Tencent’s WeChat have over one billion active users and companies are becoming increasingly sophisticated in the use of social media, while technology companies themselves are tapping in to the streams of consumers through innovations like mobile payments and use of big data. JNBY, a high-end fashion brand, is an example of a company benefiting from China’s higher-end spending of its urbanites, while effectively using technology to bring its brand to consumers. “I bought a JNBY top last year and was signed up to their WeChat account. I now get targeted interactive magazine-type advertising via WeChat that is very influential in making me want to buy something else from the company”. Consumer services also feature strongly. For example, education is a strong theme, reflected in New Oriental Education, a leader in the afterschool tutoring market. Hyomi points to the large discrepancy between demand for quality education and supply in China, noting it is a discretionary expense parents are reluctant to cut back even in a downturn. Once again, the use of technology is crucial, as they successfully use online tools for students. There are also a couple of pre-IPO unlisted stocks in the portfolio within the technological innovation theme – one of these is Bytedance, maker of the popular TikTok app which is reshaping the way content is consumed online. “It has gained market share from almost none five years ago to 15% of China’s total time spent on mobile, that’s equivalent to Baidu’s total time spent as of last year,” Hyomi says. Hyomi’s stock selection philosophy is that “great businesses win the long-term race”, and this approach underpins a strong performance record for the Fidelity China Consumer Fund as the domestic consumption story in China continues to evolve and gather pace. “Understanding the mindset of the consumer is crucial, so every year I undertake a fortnight homestay in a different city to get deeper insight into how families across the country spend their time and money. Being an avid consumer myself also helps!”

Hyomi Jie’s £142m Fidelity China Consumer Fund taps into these trends through stockpicking in the consumer goods, consumer services and technology sectors, with a growth and quality bias. “My universe is really about what Chinese consumers buy and how they buy,” the manager says. What Chinese consumers buy is changing rapidly as they become more affluent and aspirational. In 2015, just 10% of China’s total population had an annual disposable income per capita above $10,000 and this is expected to grow 3.5 times over the next 15 years. “That’s a massive opportunity,” says Jie. “We know that, when people become wealthier, the things they want to own, eat and experience changes a lot. I don’t think it’s a three or five year story but a decades-long story. But it’s not just about what people are consuming and the way people consume is rapidly developing. “The relationship between the consumer and technology has progressed at an incredible rate. The innovation of mobile technology, interaction with consumers and mobile payments already surpasses the West, and we can expect even more as the 5G network rolls out next year”.

he story of the Chinese consumer is one of the most exciting in the world, and it has decades still to run, powered by the twin themes of urbanisation and the rising middle class.