Fidelity China Special Situations: Why it's best in class

Our investment analyst looks at funds and trusts exposed to China as part of a diversified portfolio.

With Chinese New Year approaching on 5 February, investors will be hoping for a double-whammy as we enter the year of the pig, with a positive outcome from end-January trade talks combining with a pick-up in industrial activity, as China’s economic engine finally starts to pick up speed heading into the New Year.

Rebecca O'Keeffe, Head of Investments at interactive investor, talks us through the outlook for China, whilst investment analyst Dzmitry Lipski takes a closer look at Fidelity China Special Situations (LSE:FCSS).

Fidelity China Special Situations is the only China specialist in interactive investor's Super 60 list of high conviction investments. Dzmitry Lipski considers it the best in class across the collective's universe. It uses all of the unique tools in the investment trust sectors box, such as gearing and the ability to invest in unquoted companies. He also takes a look at funds and investment trusts with exposure to China as part of a more diversified mix.

Prospects for China – technology to be battleground with US

O'Keeffe said: "China's economic growth has sagged to multi-year lows in the face of Trump's trade tariffs.  China's response to this has been a raft of stimulus policies, both fiscal, monetary and regulatory.  

"So far, these efforts to stimulate the economy have gained very little traction, but this may in part reflect the natural hiatus that exists in the Chinese economy prior to the annual New Year holiday.  Investors will be hoping that industrial activity in China finally begins to benefit from these stimulus measures as we move into the year of the pig. 

"It is technology which now represents the epicentre of the economic battleground between the two largest economies in the world.  China's tech has historically lagged behind US tech, but now we have a situation in which Chinese tech is every bit as good as the US, and in some cases better. 

"While the US economy was firing on all cylinders, Trump was happy to ratchet up pressure on China via trade tariffs.  Unfortunately, this is no longer the case, not least since the tariffs currently under consideration are having a direct negative effect on the major US tech companies.  

"For companies such as Apple (NASDAQ:AAPL), much of their production is done in China, and – until now – China represented their largest growth market.  Tariffs have changed that landscape completely, with collapsing sales in China reflecting badly damaged customer loyalty as much as the widening disparity in price and quality of the latest Chinese vs US technology.  This was clearly evident from yesterday's profit warning from US chip giant Nvidia (NASDAQ:NVDA), which blamed a major downgrade to its outlook on a deterioration in demand from China.

"Trump needs a win in the ongoing trade talks, but that is not stopping him from keeping up the pressure on Chinese tech companies via individual investigations and prosecutions for violations of IP rules, as Huawei is finding out to their cost."

Fidelity China Special Situations – comment from Dzmitry Lipski

Background

The trust provides broad, diversified exposure to Chinese equities, including 'H' shares listed in Hong Kong and mainland-listed 'A' shares. It has been managed by Dale Nicholls since April 2014. He focuses on faster growing, consumer-orientated companies with robust cash flows and capable management teams. 

The trust features a diversified portfolio of 130-140 high quality stocks and is likely to have a bias to the under researched, small and mid-cap space. Nicholls is also permitted to invest in unquoted stocks and use gearing to enhance the trust performance. 

The portfolio is relatively concentrated, with the top 10 holdings making up almost half of the trust. The largest sector exposures are IT and consumer discretionary with no holdings in banks or property, which are considered higher-risk sectors. Since its launch in April 2010 the trust has considerably outperformed both the MSCI China index and its peers. 

Exposure

As China is increasingly recognised as being a major driver of global growth, investors should consider having exposure to China when building a balanced portfolio.

Growth of the middle class and the refocusing of China's economy towards domestic consumption are expected to be key drivers of economic growth and the stock market in coming years. Millennials are a key driving force behind domestic consumer growth, particularly in the 'New China' sectors including internet, e-commerce and insurance, which have boosted stock market returns.

The trust was an early investor (under previous manager Anthony Bolton) in Alibaba (NYSE:BABA) and Tencent (SEHK:700), both of which have grown to become some of the largest ecommerce, social media and gaming companies in the world. 

Following the recent inclusion of mainland-listed A-shares in MSCI China index, the domestic stock market has become more appealing to institutional investors. The manager has significant exposure (more than 10%) to the A-share market, taking advantage of Fidelity's trading licences in China. 

Opportunities among small and medium-sized companies are under researched and therefore potentially attractively valued. In addition, there are also early stage, unlisted opportunities within the sector. The trust can invest up to 10% of the portfolio in unlisted companies with a view to an IPO. It currently has six unlisted holdings with total weight of over 5%.

Strengths

The manager, Dale Nicholls, has delivered strong returns for investors since inception and has developed a strong track record as a stock picker in the Chinese market. He took over the portfolio from Fidelity's Anthony Bolton in 2014. He has also been managing the successful Fidelity Pacific Fund since 2003. 

The unconstrained strategy allows Nicholls the freedom to pursue the best opportunities available within Chinese markets. He is based in Hong Kong and supported by Fidelity's 'army' of research analysts 'on the ground' in Hong Kong, Singapore and Shanghai.

From April 2014 to the end of 2018, under Nicholls management, the trust has delivered strong returns; beating its benchmark, MSCI China index, and peers from both the closed-ended and the open-ended space. 

A new variable fee structure was introduced in July 2018, its 1% annual management charge and additional performance fee have now been replaced by a new charge of 0.9% that can vary by 0.2% depending on its NAV returns against the benchmark, the MSCI China index. 

The closed-ended structure allows Nicholls to employ gearing and to invest in less liquid, smaller and unquoted stocks. 

Risks and Portfolio context

Due to the trust's single country exposure, its bias to small and mid-sized companies and its ability to use gearing, its return profile is likely to be more volatile, making it higher-risk and a satellite (adventurous) holding in a well-diversified portfolio.

Alternatively, investors could also consider a broader Emerging Markets or Asian fund from the Super 60 that can adjust exposure to China, as a more appropriate way to invest in the country.

Source: Morningstar at 31 December 2018

Cumulative performance %

Source: Morningstar at 31 December 2018

Discrete performance %

Source: Morningstar Direct as at 31st December 2018. Price returns in GBP.

Past performance is no guide to the future and the value of investments can go down as well as up and you may not get back the full amount invested.

If you enjoyed this article, you may also like other funds picked for interactive investor's Super 60 range of high-conviction investment ideas. Click here to find out morehttps://www.ii.co.uk/ii-super-60.