Tap China's potential with Fidelity China Special Situations

IC TIP RATING

Tip style: GROWTH

Risk rating: HIGH

Timescale: LONG TERM

Charles Tan, investment companies analyst at Cantor Fitzgerald, argues that the market fall is over due given the strong rally Chinese equities have had, and demand for Chinese mainland listed shares may increase following the introduction of a scheme known as the Shanghai-Hong Kong Stock Connect. This will connect Shanghai listed A shares to the Hong Kong stock market and allow foreign investors to trade around three quarters of the Shanghai Exchange's market cap.

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If you are persuaded by the argument for Chinese equity potential over the long-term then a good way to play it is Fidelity China Special Situations Fund (FCSS) which is trading at a discount to its underlying net asset value (NAV) of 11 per cent. We tipped this investment trust as a 'buy' in March 2014 at 104.5p for reasons including its discount to net asset value (NAV), a new manager with a good record and a cut in its fees, and these arguments still stand. If the performance continues to do well and sentiment on China changes the discount could tighten, while the ongoing charge is likely to fall.

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The trust has a strong performance record since its launch in 2010, beating its benchmark MSCI China over one and three years, though much of this is attributable to its previous manager, star Anthony Bolton, who retired in April 2014. However, his successor Dale Nicholls came with an excellent track record in running Fidelity Funds Pacific Fund (LU1033664373). He is also supported by a strong team which includes five Shanghai based analysts, and Mr Tan believes Fidelity has a good investment process.

Read our interview with Mr Nicholls

The trust has a flexible investment policy which allows it to invest in areas such as small-caps and unlisted holdings. "Alibaba (BABA), which did an initial public offering (IPO) in September 2014, is a good example of how this was employed effectively," says Mr Tan. "Fidelity China Special Situations invested in the then-unlisted Chinese internet company by purchasing convertible shares in 2012, at an implied valuation of $48bn versus the current market cap of about $260bn. The trust also has the ability to enhance returns and manage risk by borrowing or holding cash, and shorting stocks, where appropriate."

It has a market cap of £771m, making it larger and theoretically more liquid than sector peer JPMorgan Chinese Investment Trust (JMC), and it has also outperformed this trust over one and three years. Cantor Fitzgerald data also shows that since its launch Fidelity China Special Situations has beaten many open-ended China funds.

Risks remain: Chinese GDP may slow further, debt levels are rising and property prices are falling. However, Mr Nicholls argues that even if GDP growth falls to 6 per cent it is still an enviable growth rate and a positive environment for corporate earnings - especially sectors which policy makers have said should play a larger role in the economy.

He adds that rising debt to GDP is largely due to state-owned enterprises, and though non-performing loans are likely to rise the trust doesn't hold mainland banks and is underweight financials relative to its index.

So if you want to get exposure to the long-term prospects for China via a fund run by a manager with a strong track record on a wide discount, Fidelity China Special Situations remains an option to consider. Buy.

Source: Morningstar as at 19 January 2015.

Performance

Source: Morningstar as at 19 January 2015

Top 10 holdings as at 30 November 2014

Sector breakdown