Stocks are simple. All you do is buy shares in a great business for less than the business is intrinsically worth, with management of the highest integrity and ability. Then you own those shares forever. I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.

February 21, 2010

Anthony Boton: Why Start China Fund

In getting us out of the financial crisis we have just been through, many western governments have effectively mortgaged the future.

The combination of governments having to repair their balance sheets, consumers rebuilding saving ratios and constraints on credit growth due to the weak state of the banking sector will result in slower growth than before the crisis – particularly in the US, UK and Europe.

This will become apparent once the strong recovery phase we are now in runs its course – probably by some time next year.

Because of this, the faster growth being seen in economies such as China’s will appear relatively attractive and I believe
that a lot of money will continue to flow into the region from investors in the developed world.

Jim O’Neill, head of global economic research at Goldman Sachs, has said: “What is going on in China remains, quite simply, the most remarkable and important economic story of our, and possibly our children’s, generation.” I totally agree.

The situation in China today is very similar to that in Taiwan or South Korea during their fast growth phases 20 or so years ago – and in Japan before that.

However, growth is occurring on an even bigger scale because of the enormous size of the Chinese population.

Just as consumers in the west start to rebuild their savings rates, consumers in China are likely to start running down their very high savings.

Many areas of the economy are in the steepest part of their development curve as consumer incomes reach a level where increasing numbers of people can aspire to own homes, cars and household goods.

Because of the scale of what is happening, and the effectiveness of a centrally-
run economy that other emerging markets do not enjoy, the world may never see anything like this again.

All of this is why I am deferring my retirement and returning to running money. I have become increasingly convinced by the investment opportunities available in China today.

I recently spent three months based in Fidelity’s Hong Kong office and this rekindled my interest in the region – and China in particular.

After a few weeks there, I said to my wife that the exciting opportunities available in China, and my belief that the market could go a lot higher over the next few years, made me wish I was still managing money.

Rather to my surprise, she said that as I only had one life I should consider running a fund again while I still had the opportunity. I spent the next few weeks discussing the idea with my family and senior colleagues before deciding to give it a go.

No-one should imagine the ride will be smooth. China is an emerging market and the volatility of its stock markets will remain higher than in developed markets.

Although it would have been wonderful to have started a new fund at the beginning of this year when all stock markets were in the “bargain basement” category, I believe China is still fairly valued today rather than expensive.

We are only one year into the new Chinese bull market and I think it has the potential to go on for several more years.

Next year, I expect most world markets to consolidate. China will not be immune but this year
it has already experienced a longer retrenchment
than many other markets.

Could a bubble form in Chinese equities? I do not know, but many of the conditions necessary are there and a number of strategists are predicting one.

An experienced Asian observer has said: “As everyone knows, a bubble is a market that rises rapidly in which one is
not invested; if one is invested, then it is a bull market.”

I have a lot of sympathy with this view and I believe that, like bull markets, bubbles normally continue for several years.

I have been visiting China over the last five years, normally making two visits a year to see Chinese companies.

When I ran the Fidelity Special Situations Fund, I put up to 5 per cent of it into Chinese stocks between 2005 and 2007.

More broadly, Fidelity has been investing in China for more than 16 years and has three portfolio managers, as well as five analysts and three dedicated traders. We are certainly not new to the country.

I hope my experience and perspective will add to this already well-resourced team.

I will bring my successful Special Situations investment approach to Chinese stocks as well as running a fund that will benefit from China’s very attractive secular growth.

For an investor like me, the opportunity is simply too great to pass up. My retirement can wait a while yet.

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Published: October 16 2009 18:12 | Last updated: October 16 2009 18:12

In an attempt to dig us out of the financial crisis, the governments of many developed economies have mortgaged their futures. Their unprecedented fiscal stimulus has significantly increased the ratio of public debt to national income. Consequently, I believe that the growth rate to which these developed economies will return – once the short-term recovery phase is over – will be lower than in the past.

This has important asset allocation implications for investors in developed market equities.

To understand the nature of the recovery that we have been experiencing over the past six months, we need to examine the decline that preceded it. The downturn was very much corporate rather than consumer-led. Across the globe, and simultaneously, the financial crisis led chief executives of companies to cut inventories, capital expenditure and staff numbers.

As a result of this synchronised action, the economic data in the last quarter of 2008 and first quarter of 2009 looked terrible.

More recently, conditions have reversed as companies have regained their confidence and started to rebuild inventories, leading to a slowing in the growth of unemployment. However, the financial crisis has left us with longer-term problems, particularly relating to the consumer, which will overshadow world economies once the initial recovery phase is over.

My contention is that a combination of consumers rebuilding their balance sheets, slower credit creation in this upturn than was historically the case, and governments being forced to cut spending or increase taxes will lead to lower growth than before the crisis.

The big question now is whether the relative growth advantage of emerging markets over the developed world has increased.

I think it has – particularly for emerging markets that are driven by domestic demand and investment. I am less keen on those markets where exports or commodities are the main drivers. One reason these are less attractive today is the fact that commodity shares and industrial companies were the leaders of the last bull market.

In my experience, it is unusual for sectors that are the stars of one bull market to take the lead in the next, particularly if share prices in the late stages of the previous bull market enter a “bubble” phase as they did in 2006 and the first half of 2007.

In the first phase of a new bull market, investors sometimes do return to play the winners of the last cycle but this does not prove sustainable.

The best conditions for commodities are either synchronised above-trend world growth – as we experienced in the last bull market, and which we are unlikely to see any time soon – or strong inflation.

My view on inflation is that it may be a longer-term threat but that it is unlikely to be a problem in the next couple of years because of the low growth environment and excess capacity in the west.

Finally, from a shorter-term perspective, some of the extraordinarily rapid credit expansion in China this year has been used by companies to stockpile commodities. As this credit expansion now slows, and as Chinese companies use up their excess inventories, I expect demand for commodities in the near term to be softer.

I don’t think that low growth in the US and Europe is necessarily bad for equity investment in general. Low interest rates that will accompany this sub-par growth will lead investors to seek the higher returns offered by risk assets such as equities, corporate bonds and property. I have been arguing that this will drive a multi-year bull market (especially as cash on the sidelines is still high and a number of professional investors remain very cautious).

Even so, the equity market may need a sustained period of consolidation, probably next year, as this first phase has been so strong.

In an environment of lower growth, I expect investors to seek out companies, sectors and countries that can grow faster than average. So, in the next stage of the bull market, growth will be rewarded – and I expect that it will be rewarded by investors with higher valuations than is normally the case.

If that is the case, then UK investors’ typical exposure to emerging markets, of about 15-20 per cent of an equity portfolio, could prove too low. Perhaps, for the next few years, they should consider having a majority of their exposure to markets that can provide higher growth.

But if all investors in developed markets make similar changes to their asset allocation, I believe we will have all the ingredients necessary for a new bubble to develop over the next few years in these volatile but rewarding markets.

Fasten your seat belts – we are in for a bumpy, but enjoyable, ride.



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