25 February 2010

Dear Fellow Investor

Have you been thinking that you should be invested in China but do not know how to go about it?

This weeks newsletter may give you the answer, as a legendary UK fund manager (comparable to Peter Lynch) comes out of retirement to start a new fund focused on China.

Below is an interview Jonathan Davis (Independent Investor blog) had with Anthony Bolton, the legendary UK fund manager.

Jonathan graciously agreed for me to use the interview in the guest post below. (Emphasis mine)

Saturday, January 30, 2010

Anthony Bolton of Fidelity needs no introduction to investors, having managed the UK’s most successful equity fund for 27 years from 1979 to 2007, during which period Fidelity Special Situations outperformed the FTSE All-Share index by the extraordinary margin of 6% compound per annum.

Late last year, to the surprise of many professionals, he announced that he was coming out of retirement in order to launch a new fund to invest in China.

In these exclusive extracts from an extended Q and A with Independent Investor he explains why – as well as what he is expecting from developed markets in 2010.


You have nothing to prove as a fund manager. What is the attraction of managing a Chinese fund?

There are several reasons. The first thing is the general case for China. Here is the third biggest economy in the world, which is likely, this year or next, to overtake Japan and become the second biggest economy in the world. It’s currently the ninth biggest stock market, and in the next 20 years or so, it will become the second or third biggest stock market.

There is also the S-curve effect. There has been a lot of research into emerging markets and when they tend to have their best phase of growth. It seems to be when GDP per capita is in the $4,000-$10,000 range. As the average income goes up, you get a significant and disproportionate increase in the number of wealthy people. That’s what happened to Taiwan and Korea 20-30 years ago, and to Japan before that. The exciting thing is that we’ve never seen an economy as big as China go through this phase.

Although China is a command and control economy, which has some negative aspects to it, what also impresses me is that the top politicians in China are well-educated and international in their outlook. Their plan for what they want China to be in the future is really exciting. When they do things, when they say “we’re going to change the hospital system, we’re going to put in a high speed electric train network” or whatever, it tends to happen, and happen quickly.

The public spending on infrastructure is hugely impressive, as anyone who goes there can see. India and other countries are also exciting, and though I don’t know them so well, it seems that they do get very bogged down in politics. There are obviously some long term questions about the Chinese system of benign dictatorship. Once people become better off, at some stage they want more freedom, and so that’s a challenge for China down the road. But it is still a few years off.


And China looks a more attractive place to invest than many developed countries?

Yes. The second reason is very much what’s happening in the West. My view is this has been a different type of recession to a normal recession. It has been the most extraordinary 18 months, and quite unlike most recessions that I’ve experienced, which tend to creep up on you slowly. You often only realise you’re in one when you’re halfway through it. What happens then is that the consumer tends to lead you out of it.

This recession is different because it’s been very much driven by corporates, not consumers.

My explanation is that when the financial crisis hit the headlines in the third quarter of last year, CEOs immediately said “We’ve got to batten down the hatches”. They cut inventory, they cut cap ex, and they cut labour, and for the first time ever, that happened globally all round the world. That’s why we had such desperate economic figures in the fourth quarter of last year and in the first quarter of this year.

Now we are experiencing the reverse of that. Obviously, not all the economic data is universally bullish, but the stuff that we look at suggests that there’s a pretty strong recovery and we think earnings are going to surprise on the upside because corporates, particularly in America, have really cut back so far and so fast. So while in some ways, the situation wasn’t quite as bad as it looked in the headlines at the end of last year, and at the beginning of this year, I think the reverse is true now. This fast upturn is making things look better than they really are.


What does that mean for stock markets over here?

My view is that what we’re going back to once this recovery phase has run its steam, which I think will last through the first half of next year, is lower growth in the West. Particularly in the UK, the US and Europe, governments have mortgaged the future to get us out of this crisis, so they’ve got to increase taxes or reduce spending.

Secondly, consumers are over-indebted and have had a shock. They need to rebuild their balance sheets. I don’t think they’re going to lead the recovery.

Thirdly, there’s less credit available for everyone because of the banking crisis than there would be in a normal cycle. What that all means, as far as I am concerned, is not that we are heading for a double dip or going back to a recession, but that what we are facing is a period of slow growth.

That has got quite big implications for the leadership of the bull market. Once this becomes apparent next year, the stocks that are leading the market are going to change.

There will be a broad move away from cyclical companies, and commodity companies in general (though there could be some exceptions to that), towards more growth-oriented stocks. If you’re in a low growth environment, predictable high growth is going to have rarity value and that will be bid up by investors. I don’t think it’s a bad environment for equities generally.


Does that mean a renewed bear market, as many are predicting?

I don’t think the bull market is about to end, but it might have a big pause. We haven’t had a big pause yet, so as the leadership changes, we could have a three month or so of setback and consolidation in markets before the next stage.

In this lower growth environment, governments are going to be very slow to exit their support measures. I think that markets can take some rise in interest rates. I don’t think the first rise would kill the bull market, but if we then get into a succession of interest rate rises, at some stage that will stop the bull market. I suspect that is a 2011 rather than a 2010 story.


Meanwhile all this is positive for China and Chinese equities in particular?

Yes. What it means is that if China can continue to grow, it will look increasingly attractive. While it is obvious that emerging markets are not immune from growth trends in the West, if an emerging market, through the momentum in its domestic economy, can continue to grow at above the world average rate, that will make it more attractive to Western investors. The net effect of what I see in all this is that more money will flow from Western investors into markets like China.

At the same time, while there seems to be a case against every other currency, most people would agree that the remnimbi is undervalued. It seems likely therefore that if you invest there, you are going to make a currency gain there. Nobody quite knows when they’re going to relax their currency policy, but it is almost inevitable that they will. Their programme is to gradually open up the currency, and that must lead it to appreciate.


What sort of fund do you expect your fund to be?

It is going to be volatile, and so you’ve got to know the animal. That’s one reason why I have something of a preference for a closed-end fund, or an open-ended fund that has some restrictions around it.

You need that as China is a market where people can panic very easily, and if something goes wrong, you don’t want to have to liquidate everything you own.

Continued growth is near the top of the list of what the regime wants.

(Editor’s Note: At the time of the interview, the final details of the fund had still to be detailed. It will be launched formally in the second week of February 2010).


Your focus will be solely on Chinese companies or will you playing the theme other ways as well?

I’ll have some room. The bulk of the fund will be in Chinese companies, by which I mean

(a) the ones listed in China either H-shares, A-shares or B-shares;
(b) Chinese companies that are listed in America (there are quite a few of those in the technology area);
(c) and Hong Kong listed companies that are a play on China.

I see that being the main part of the portfolio. I will have some room though to buy Chinese plays elsewhere in the world. What I mainly want to do is focus on a smaller universe than I’ve been used to. I don’t want to have to look at every market in the world. I mainly want to focus on listed Chinese companies, but if something comes up elsewhere that has a strong Chinese angle to it, I don’t want to rule it out.

I could have 10 or 20% in those stocks. The prospectus may alter that slightly, but that’s the sort of range I have in mind at the moment.


What resources will you have to help you manage the fund?

We’ve been investing in China as Fidelity for about 15 years. We have three managers there who run Chinese-focused or Greater Chinese funds, about $4 billion in total.

There are five analysts who focus solely on Chinese shares plus our sector analysts. The oil analyst for example covers all the oil shares, including the Chinese ones.

We’ve also had a private equity business in China for 14 years. We only do private equity with our own money. It’s a way of diversifying the balance sheet as a private company.

We own property, such as this building, and we also have private equity, including some interests in the UK. What the private equity people have is a good network. Knowing who you can trust and who you can’t trust is very important. Being able to plug into that network will help me a lot in the corporate governance area.

I’ve already seen a lot of companies with H-shares, well over a hundred in the past six years. I need to do more work on A-share companies. As you know, for A-shares you need a quota. We’re negotiating one now. You never know when or how you’re going to get it, but in the meantime, you can use broker notes as an interim measure. I have invested in some A-shares in the Special Situations Fund. It’s quite a big market and it’s one of the areas I’m going to be focusing on in the run-up to the launch of the new fund.


What about the trading characteristics of these shares: are they not less liquid and so on?

The trading is tougher. You need traders and you need to be patient. You can’t always buy them on the good days. You may have to buy them on the bad days, but I am used to that in medium and small-sized stocks here.

Taking a slightly longer approach should help with the trading, so I’m going to be a bit contrarian in the trading. Relative to the funds we have, I will have a higher tracking error and more active money, and probably more in medium and small sized stocks.

There are some very lumpy shares at the top of the list. China Mobile is nearly 10% of the index, and some of the banks are 6% to 7% of the index. China Life is a similar size. So if I like them, I might want to have quite big holdings. I used to start at 25 basis points in Special Sits. I’d hope I might be able to start at 50 basis points here. We will have a more concentrated portfolio than I did in Special Sits, but it depends on the amount of money we have, and other things. I very much want to cap the amount of money. That’s my ambition.


What do you say to those who say you will not be able to succeed in China – the different culture, the language and so on?

There are obviously some factors that are unique to China, and it doesn’t have the really attractive valuations that Europe had in the 1980s, when I started my European fund. But while China is different, I feel strongly that the basics of investment are the same whichever market you’re in.

There are also many similarities to the situation in a market like Germany at that time. I remember in Germany, when I first started going there, that local investors were very short-term. They couldn’t understand why were we interested in meeting the companies and understanding them and trying to work out where they were going over the next one or two years.

At the time all they were interested in was trading. I see that as one of the characteristics of a market that has not yet fully evolved. China is at a similar stage. Part of the Chinese trading mentality is to do with that.

Also, there’s an issue of loss of face. They don’t like to be associated with things that are not doing well. All that makes it an interesting place for a value investor such as myself, despite the conventional wisdom being that you have definitely got to do it differently in China.

An American organisation called Empirical Research, which is very quantitative in its approach to markets, has done some excellent research on emerging markets. They did a big piece earlier this year on emerging markets, which showed that valuation is the major driver of returns in emerging markets, and that it’s an even bigger return in emerging markets than it is in developed markets. It applies both in general and specifically to China H-Shares. (They haven’t analysed the A-shares yet). So that’s exciting.

The other aspect is that China’s going to have a lot more IPOs, and more of them are going to be coming in the companies which are oriented towards the domestic economy and service industries.

Again, that’s a bit like Europe in the 1980s, where the history was manufacturing, and to some extent financial, but then you had more and more companies coming to the market from retailing, advertising, media or whatever. China is going to do the same thing.

I think that people like me who have seen similar companies over so many years have an advantage. For example, the first Chinese drug distributor, Sinopharm, was listed recently. It has gone to a very high valuation today, so in the short-term it’s probably not that interesting. But the point is that Chinese investors had not seen a pharmaceutical distributor before, so they are not sure how you should value this kind of company. There will definitely be cases where my knowledge of those industries in other markets will help me locally.

On the negative side, policy is undoubtedly both a risk and a reward in China. Because it’s so centrally driven, they can change the rules overnight. The first thing to be aware of is that that’s a risk. You’ve got to try and work out which companies are more exposed to that risk than others. Obviously you need to do some listening to people who are close to the politicians, to get an early warning of change.


What about corporate governance? Surely that is a big concern for any Western investor?

Corporate governance, the quality of the information, the quality of management, etc. is a much debated issue. Hong Kong listings certainly provide better quality information than the Shanghai and Shenzhen listings.

My experience of the companies that I’ve seen, and there are a few now that I’ve seen half a dozen times, is that the good ones are as good as anything in the UK or Europe.

Quite often, these are private companies run by Chinese people who’ve lived in the West. When China has opened up, they’ve come back to China, seeing the opportunities. On the other ones, the bad ones are pretty bad. There’s a wide spectrum.

If we had met a year ago, I would probably have said that I would mainly want to focus on private companies. I spent quite a lot of time talking with my analysts about that when I was in Hong Kong. They persuaded me that avoiding all state-owned companies was too black and white a view of the world. Some of the state-owned enterprises are actually run by decent people. Some of the people who run companies are quite politically ambitious and they want to prove themselves as a stepping stone to bigger political ambitions. So, if they mess things up, that’s a problem.

There are also specific issues for specific industries. The one that my colleagues particularly talked to me about was property development, where, they say, the state-owned enterprises tend to get better deals because they’re closer to the local politicians. If you’re a private company, it’s more difficult to get the good land deals that are at the heart of successful property development.

But the last thing they pointed out is that the biggest scandals over the last couple of years have mainly been in private companies rather than in state-owned companies. I am going to buy some private companies and some state-owned enterprises. They both have their risks and rewards. I’ll put a lot of time on trying to work out who’s good and who’s bad.


Have you come across corruption issues? People have had those issues in Russia and elsewhere…

I was debating with one of our analysts about a stock that she was following. It was on six times earnings, and she said: “It’s really cheap – should I recommend it?” I said: “What’s the snag?” She said, “The management’s been moving interest between the listed company and their private companies, to the expense of the listed company.” My reply was: “If they’re doing that sort of thing, you shouldn’t buy it at any price. There isn’t a known valuation that compensates for that.”

There is also the case of Gome, which has been in the papers. It was the Dixons of China, the biggest of the electrical/electronic retailers. I met them three times. I met a lady director, and it was only on the third time that I clicked who she was. She was the wife of the Chairman. (Husbands and wives have different names in China). I said to her in the meeting: “I wish I knew that before because that’s a material fact“. But she couldn’t understand why it was relevant. She said, “Just because I’m married to the Chairman, what’s that got to do with it?” It so happened that Gome then blew up and the Chairman’s currently in jail, so I was lucky to avoid that one.

So yes, there are risks there, and I’m sure we won’t discover every one. We will make some mistakes, but hopefully not too many. When I am talking to the team, if I go through the list and come up with the stocks that look really cheap, one of the three fund managers may say to me, “Anthony, we don’t really trust them. Make up your own mind, but our advice is don’t invest in that.” I’ll normally go by that.


How much time are you going to be spending in China as opposed to working from Hong Kong?

I haven’t finally worked that out. Hong Kong is a pretty good place to see Chinese companies, because one of the problems in China is that companies are quite spread out geographically.

I will definitely go to China, but how often I haven’t decided. It must be at least every six to eight weeks, I would have thought. I want to go to some of the second and third tier cities, which I’ve not been to before.

Nevertheless, if China companies go anywhere to see investors, they go to Hong Kong, and then there are quite a few key conferences which is a very efficient way to see a lot of companies in a short space of time. We tend to go and have our own agenda of one-to-one meetings at the conferences.


Have you found that getting access to people is any easier than it was in Germany in the 1980s?

Access can be an issue, but companies are starting to find it more interesting to meet. They’re also at the stage where they’re now realising too much of it can be rather a bore as a management, so they’re getting a bit more discerning about who they see.

With Fidelity’s influence, and hopefully now with me going there, and all the publicity around that, if anyone can get access – well, if we can’t, I don’t think anyone can.

All three of the managers and the five analysts in our team are all Chinese, and I’ll work pretty closely with them. The language is obviously an issue. I’m not going to learn it. I’m not good at languages. But that was an issue, again in Europe, and that never seemed to be a problem. I will need to use the team to help me on the nuances that don’t come across in the translation.


How well did you do with the Chinese companies you invested in through the Special Situations fund?

I did well. I don’t have any detailed attribution statistics to prove that to you, but were a couple of pretty successful domestic companies.

Li Ning, which is a sportswear retailer, which did pretty well for us. Another retailer called Ports Design is China’s only women’s fashion retailer and they’re trying to build their Ports brand, which they want to become a world brand in women’s fashion. And there were others.

The market is definitely inefficient when you get outside the leaders and the very fact that you can have the same company with A-shares and H-shares on completely different valuations is a reflection of that.

There’s a company in one industry that I’m interested in and it’s on about 11 times earnings and some of its competitors are on 30 times earnings. I can’t currently understand why there is such a big difference. There are going to be a few outright value stocks, but my approach will I think be more of a GARP-like approach than pure value.

There are a group of stocks in China which have potentially 10 years of growth ahead of them. They are not cheap, but they’re not highly valued as similar US and Australian companies whose valuations might be in the high teens or low twenties.

If the long term story is good enough, I’d be prepared to buy stocks like that, even on a 20 multiple, if the franchise and the long term prospects are good enough. Value doesn’t mean it has to be only a single figure multiple. I can’t argue that the whole market is very cheaply valued. It’s more in line with its average over history.


Jonathan Davis
Independent Investor


About Jonathan Davis
I have been analysing investment markets for more than 30 years, initially as a journalist on The Times, The Economist and The Independent, more recently as a columnist, author and investment professional. I am Investment Director of Agrifirma Services Ltd and a Non-Executive Director of Hargreaves Lansdown plc. Any personal views expressed on this website, or in the newsletter, are entirely my own.

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Huge inflows usually happen when the fund has had a healthy increase and there may not be as many attractive assets left and outflows after a substantial decline when liquidity is low and assets have to be sold at fire sale prices and when price declines have made attractive assets available again.

Here is Fidelity’s web page on the new China fund.

And here is one bloggers take on the fund:

Should you back Bolton in the China shop?

Six reasons to back Bolton’s China investment trust

Six reasons not to invest with Bolton in China

Bolton’s China trust is worth a small punt


Sunday night we had another 15cm of snow and Monday morning everything was so slippery I could hardly get my car out of the underground garage.

Driving to the office was also quite an ordeal with the car struggling to pull away from quite a few traffic lights because of ice on the road. Furthermore the roads felt like a small gravel road in Africa because of all the potholes caused by the snow and ice.

As you may notice I am really fed up with winter!

But as I mentioned last week, there is hope. On Saturday Nikki and I am off to visit friends in Singapore. I am now looking forward to it even more.

Your nearly on holiday analyst



Tim du Toit

P.S. A media company in the wrong country at the wrong time...