Renowned Fidelity fund manager Anthony Bolton has warned the outlook for China is 'grey' and urges investors to be cautious of accessing the market via index funds.
Bolton also takes the view that investors are too preoccupied with debt levels in China and are not paying enough attention to the impact of political change.
'The outlook for China, rather than being black or white is more grey. It is more about the balance of different factors,' he said, adding that many people are worried about financial matters such as debt levels, when political reform was the key issue.
'I have always thought the real challenges for China are more medium term challenges,' Bolton said.
The manager of the Fidelity China Special Situations investment trust is forecasting 'five to 10 years of political change' ahead under the new regime. In his view, the Chinese government are 'very aware' of the issues facing China and clear on the need for reform.
This promise of change was outlined in the Third Plenum, a rare meeting of the top Chinese officials that Bolton said had produced 'a very radical programme' of wide ranging reforms, including easing the path for foreign investment in China.
Bolton views the Chinese market as 'pretty cheap relative to its history', not far off 10-year lows in terms of valuation. Nonetheless, he acknowledged the scepticism of foreign investors given that China has been 'one of the least good markets to invest in the last few years'.
He suggests that investors need to be more discerning about the way they gain exposure to the country, particularly those who do so via index funds.
'What you don't want to own in China is an index fund,' Bolton argued, because of the exposure to large state-owned companies. Instead he has a large exposure to the private sector, and is geared towards consumer spending.
'The big infrastructure spend is not going to disappear but the big days of that are over. The focus is now on the domestic economy,' the manager said.
His three key overweights are IT (including internet companies), consumer discretionary, and pharmaceuticals.
Bolton insisted there was a place in portfolios for some native Chinese companies rather than purely targeting international brands - even though he has lost money on such bets in the past.
'Some people think the best way to invest in China is by the big names like BMW, but even growth investors should have some money directly in the space. It's always diluted and you are always getting some other exposure as well. I think you should have some money in the pure Chinese stocks,' he said.
Fidelity China Special Situations investment trust's share price has risen by 33.2% on a total return basis in the year to October 31, compared to a rise of 9.6% for the benchmark MSCI China index. In three years the trust's share price has fallen by 16.8 per cent, compared to a fall of 1.1 per cent by the index.
'One of the key mistakes investors make over China is to apply western rules and then come to a number of conclusions. It leads people to have a polarised view of China- some very negative and positive,' the manager, who retires in April, added.