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Chinese consumer growth story boosts Fidelity China Special Situations

Fidelity China Special Situations is continuing to find growth opportunities in consumer stocks, e-commerce and unlisted companies
March 16, 2017

Fidelity China Special Situations (FCSS) has maintained strong performance over the past year, with a share price return of 49 per cent, compared with 45 per cent for MSCI China Index. The trust has also done well over three and five years, with share price returns of 84 per cent and 139 per cent, respectively, compared with 62 per cent and 63 per cent for the index.

Despite this, the trust is trading at a discount to net asset value (NAV) of 14.5 per cent, which chairman Nicholas Bull admits is frustrating for its board, but says is also a good buying opportunity for investors.

"There's a certain cynical portrayal of China that concentrates on high debt, empty cities and human rights," he says. "The other thing people will often ask is 'when's the hard landing?' But when we travel to China, what we see is the growth of the middle class both in size and in wealth. They are not bothered by what happens in the US, they want healthcare and good education for their children, and that has considerable momentum."

Fidelity China Special Situations' manager, Dale Nicholls, acknowledges that there's potential for some Chinese industries to be targeted with high tariffs by the new US administration, but says the trust's direct exposure to the US is very small at roughly 2 per cent. And although the pace of growth in China has slowed lately, the quality of growth is improving.

"Whatever the final number is on gross domestic product (GDP), consumption is going to be growing faster, which is a really good environment for picking stocks and where we have been able to deliver alpha," he says.

There is a wide variance between different parts of the economy, he adds, but the trust remains focused on exploiting opportunities in the 'new China', domestic consumer-driven areas of the economy.

These include IT businesses, which make up a third of the trust's portfolio, such as unlisted e-commerce company Yiguo, which Mr Nicholls added at the end of last year.

Yiguo is an online groceries business aiming to create a 'farm-to-table' e-commerce platform. It has an affiliation with Alibaba (BABA:NYQ), a leading e-commerce business in China, which the trust has also held since before it listed. "I see Yiguo as the clear leader in online groceries and they get all Alibaba's online traffic and network, which is a huge competitive advantage," says Mr Nicholls. "This is a relatively underdeveloped area in China, but one that - like other 'new' consumer-related sectors - offers huge growth potential."

Last year shareholders approved a doubling of the trust's investment limit on unlisted securities from 5 per cent to 10 per cent of gross assets, increasing its ability to invest in opportunities in a very entrepreneurial environment.

Another unlisted stock the trust holds is Didi, a technology-driven taxi service similar to Uber, but which in China has beaten Uber at its own game. In August, Uber agreed to sell its business in China to Didi. "This company in China is delivering more rides than Uber globally," explains Mr Nicholls. "It has about 400,000 drivers in Shanghai alone, so the potential over the mid term is strong."

The trust also has a significant weighting to consumer discretionary companies, which account for more than a third of the portfolio. These include Yihai (1579:HKG), a Chinese condiment brand. The company has 35 per cent of the mid- to high-end condiment market in China and Mr Nicholls says its affiliation with a successful restaurant group - Haidilao Hot Pot - should drive growth.

Although 'new China' businesses remain a core part of the manager's focus, he has also been adding to state-owned enterprises (SOE), which are starting to show some positive signs of tackling inefficiencies. But he avoids banks as he is worried they have too much exposure to bad debt.

"The biggest risk in China is the growth in credit, which has seen a significant expansion in debt to GDP over the past eight years of about 100 per cent," he says. "I don't ignore SOEs, but I focus on the companies that have really good assets."

These include top 10 holding Shanghai International Airport (600009:SHH). Airports are benefiting from strong travel trends both domestically and overseas, and Mr Nicholls says infrastructure assets in China look cheap on a global basis, with toll roads and railroads looking increasingly interesting - especially if there are price increases. The rail sector has not seen tariffs changed in more than 20 years.

Fidelity China Special Situations' gearing is relatively high at 27 per cent and close to the trust's limit of 30 per cent. Mr Nicholls says net gearing tends to be high when he is finding opportunities, particularly when sentiment is negative, valuations are low and there are lots of opportunities.

Fidelity China Special Situations includes direct investments in China domestic A-shares, but has reduced its holdings in this market from around 20 per cent to 11.3 per cent of assets following a strong run.

Last year, index provider MSCI decided against the inclusion of A-shares in its China index due to concerns over access and transparency in Chinese capital markets. But Mr Nicholls thinks it is only a matter of time before it includes them.

He says: "China is on the way to becoming the biggest economy in the world, approaching 50 per cent of global GDP, and yet it accounts for less than 3 per cent of global markets. So I have no doubt that the proportion of China in global markets is going to be increasing."

 

PRICE189.5pGEARING27%
AIC SECTOR Country Specialists: Asia PacificNAV221.6p
FUND TYPEInvestment trustDISCOUNT TO NAV14.5%
MARKET CAP£1,046bnYIELD1%
No OF HOLDINGS159*ONGOING CHARGE2.22%** 
SET-UP DATE19/04/2010MORE DETAILSwww.fidelity.co.uk

Source: Winterflood as at 09/03/17, *Fidelity International as at 28/02/17, **The AIC (incl performance fee)

 

Performance

Fund/benchmark6-month share price return (%)1-year share price return (%)3-year cumulative share price return (%)5-year cumulative share price return (%)
Fidelity China Special Situations74984139
MSCI China10456263

Source: Winterflood as at 09/03/17

 

Top 10 holdings as at 31/01/17 (%)

Tencent 11.7
Alibaba Group 9.6
China Pacific Insurance 5.1
China Petroleum & Chemical 3.1
Citic Telecom International 2.4
Ctrip.com International2.4
Hutchison China Meditech 2.3
Shanghai International Airport 2.0
Brilliance China Auto1.9
CT Environmental Group1.8

Source: Fidelity International

 

Sector breakdown, as at 31/01/17 (%)

Consumer discretionary 34.5
Information technology 32.5
Industrials 18.4
Financials11.7
Consumer staples 9.1
Healthcare 5.7
Energy 5.3
Materials 4.0
Telecommunication services 3.4
Utilities2.5
Real estate 1.0

Source: Fidelity International