Fidelity China Special Sits wades into private market

The IC Top 100 Fund has 2 per cent of its assets in private companies but is seeking permission from shareholders to increase the upper limit in order to track down more opportunities such as private Chinese company Xiaoju Kuaizhi (Didi) - which is China's and the world's largest social transportation network. The trust also invested in e-commerce giant Alibaba (US:BABA) before its initial public offering (IPO) - the biggest in history - in 2014.

John Owen, chairman of Fidelity China Special Situations says: "Following the successful initial public offering of Alibaba in which [this trust] invested from an early stage, there has been a trend for companies to raise capital in private markets and to list on a public stock exchange after their development has progressed. The board is seeking to revise the limit as this would allow us to react if investment opportunities occur."

The proposed change will go to a shareholder vote on 22 July.

Fidelity China Special Situations acquired Didi in the third quarter of 2015. The company enables users to hail taxis, private cars and arrange ride-sharing through its online network and apps. Both Alibaba and Tencent (700:HKG) are strategic investors in the company. When the trust invested, it valued Didi at around US$16bn (£10.96bn). According to the trust's recent annual results that valuation has now increased to $20bn through a new financing round, which has already been reflected in Fidelity China Special Situations's net asset value (NAV).

Fidelity China Special Situations' manager, Dale Nicholls, looks for unloved stocks driven by the consumer economy, an area fuelled by the growth of the internet. Seeking out less well-known, nimble, technology-focused companies chimes with his interest in China's new economy, which he said he was homing in on earlier this year.

He is not keen on large state-owned stocks, but exceptions include Shanghai International Airport (600009:SHH), as it has expansion potential and has recorded strong earnings growth due to underlying passenger growth - a trend Mr Nicholls thinks will continue.

The trust is known for its relatively higher-risk appetite and was punished for its relatively large weighting in domestic A shares last year. But it has performed well over the long term, returning 38.5 per cent compared with 7.1 per cent for MSCI China Index over five years. However, in 2011 it lost 38 per cent against the benchmark's 17.6 per cent fall.

Over its last financial year to 31 March 2015, although the trust's NAV remained flat its share price fell 4.53 per cent - albeit a lot less than MSCI China which fell 16.17 per cent. This increased the discount to NAV, which is currently about 18.6 per cent.

The trust's focus on small- and mid-cap companies was beneficial as much of the relative outperformance was from stocks with a market-capitalisation below £5bn. And several positions in the consumer discretionary sector contributed to positive returns against MSCI China Index. Budget hotel operator China Lodging (HTHT:NSQ), for example, rallied after it reported improved free cash flow following new franchised hotel openings and an increase in pre-paid membership. And demand for New Oriental Education & Technology Group's (EDU:NYQ) after-school tutorial services proved resilient.

Investment trusts are increasingly turning to the private market to locate disruptive, often capital-light technology companies which are able to ratchet up hefty valuations without seeking public funding while also remaining more autonomous. Fidelity China Special Situations is just one of a number of trusts to home in on private stocks in recent months: earlier this year Global sector trust Scottish Mortgage (SMT) put in place an upper limit for private stocks of 25 per cent of assets, higher than the 12.5 per cent it had invested in these at the time. The trust, which we also count among our IC Top 100 Funds, claimed the most exciting opportunities are now to be found outside public markets.

Source: Morningstar

Performance

Source: Morningstar as at 5 June 2016

Top 10 holdings as at 30 April 2016 (%)

Sector breakdown (%)