Fidelity’s China equity specialists, led by Citywire A-rated Dale Nicholls, have raised concerns about the country’s banking sector deeming it ‘uninvestable’ at present.
In a market update Hong Kong-based analyst Rebecca Jiang, who works alongside Nicholls on the Fidelity China Special Situations (FCSS) investment trust, gave a scathing appraisal of Chinese banks.
‘I do believe it is an uninvestable sector for long-term investors, at least at the moment. There are a couple of concerns, including increasing leverage for the whole economy, capital misallocation, as well as the accumulated risks in the banks’ loan book and off-balance sheet commitments.’
‘I believe we need to see a few things happen; including better capital allocation and defaults need to happen just to move the implicit guarantee that financial institutions are currently bearing.’
‘We also need to see a deleveraging of the whole banking system through recognition of non-performing loans, as well as recapitalisation of the balance sheet. It is difficult to justify investing in Chinese banks.’
Nicholls, who took over the trust from Anthony Bolton in April, endorsed the comments. ‘I agree with a lot of those points and am currently underweight Chinese banks. Non-performing loans are heading higher and it is really not the time to be invested in the banking sector,’ he said.
Although Fidelity China Special Situations has just under a quarter of its assets in financials, this is mainly in insurance companies such as Ping An and China Pac rather than banks. Financial stocks make up 37% of its benchmark, the MSCI China index.
Nicholls, who has an 11 percentage point underweight to financials in the broader Pacific fund, recently suggested investors should not overlook state-owned enterprises in China. He said many investors were immediately eyeing ‘new economy’ stocks and not considering how reform would impact, and potentially aid, long-standing institutions.
Nicholls has yet to convince investors. Data provider Morningstar this week restored the trust to 'neutral' having put it under review following Bolton's departure. Analyst Szymon Idzikowski said the transition had been smooth and noted that Nicholls had an impressive track record on his Fidelity Pacific fund. 'However, Fidelity Pacific is a regional fund rather than a country-specific fund, and Nicholls has yet to prove his process is replicable here.'
The shares trade on 9.4% discount to net asset value and are up 10% year to date, ahead of the 7% gain in the MSCI China.