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Fidelity China Special Sits remains focused on tech and consumers

Manager Dale Nicholls explains where he sees the best growth potential
March 1, 2018

Fidelity China Special Situations (FCSS) has significantly outperformed its benchmark, MSCI China index, over three and five years. But over one year its net asset value (NAV) return of 32 per cent and share price return of 34 per cent are more in line with MSCI China's 33 per cent.

Dale Nicholls, manager of Fidelity China Special Situations, says the recent NAV underperformance is because the trust has lower exposure to cyclicals, such as banks, than its benchmark. Financials are the trust's largest sector underweight position because Mr Nicholls is concerned about Chinese banks' debt exposure. Although the Chinese government is taking steps to address debt, the growth of which has slowed in recent years, Mr Nicholls remains cautious on the banking system.

"I don't think a financial collapse is imminent, but I suspect there's more to come in terms of non-performing loan issues, particularly if liquidity is tightening in the system as that's when you see defaults start to pick up," he explains. "Bank [valuations] don't look expensive, in fact banks have done quite well over the past year. But for me there are just better opportunities outside that sector to invest in."

>From June this year, MSCI will begin adding Chinese A shares to its Emerging Markets index

Mr Nicholls remains focused on exploiting opportunities in the domestic, consumer-driven areas of the Chinese economy as the middle class grows. These include information technology and consumer discretionary companies, which make up more than 70 per cent of the trust's assets. Its two largest holdings are Chinese tech companies Tencent (HKG:700) and Alibaba (US:BABA), which account for more than a quarter of assets, although its allocation to them is slightly lower than their weighting in MSCI China index.

Despite these companies' extremely strong performance last year and their price-to-earnings ratios in the mid to high 20s, Mr Nicholls thinks they remain undervalued.

"Tencent continues to grow very strongly in gaming as it has the most significant gaming platform in China and is still growing well," he says. "It also owns Wechat, which is effectively the Facebook (US:FB) of China, but is nowhere near as monetised as Facebook is in terms of advertising." He adds that Tencent's platforms are approaching a billion users.

Alibaba, meanwhile, is the leading ecommerce business in China and expanding strongly in other areas such as cloud computing. "[Although Alibaba is often compared with Amazon (US:AMZN)] it doesn't hold inventory as it's a platform that stores can come on to and operate, and arguably that makes it a better model," says Mr Nicholls. "The growth it can achieve through advertising [is strong] as it has a significant amount of data that it is now leveraging."

Both companies are becoming wider-ranging tech conglomerates, for example, by expanding into digital payments - another area Mr Nicholls believes offers good growth potential. And while government regulation could be a risk, this is not an immediate concern.

"These companies are viewed as national champions," he explains. "They need to follow strict rules around censorship, but in many ways their relationship with the Chinese government is quite collaborative. We continue to monitor this issue as they get bigger. But there's a recognition by the Chinese government that they are some of the fasting growing companies, big employers and big drivers of growth."

Fidelity Special Situations bought Alibaba before it listed – it can have up to 10 per cent of its assets in unlisted companies. The trust currently has four unlisted stocks: Didi, a technology-driven taxi service similar to Uber; Jiguang, which helps app developers with marketing; Meituan, which provides online services including food delivery, restaurant booking and hotel reservation; and Yiguo, a leader in online grocery delivery in which Alibaba is the majority shareholder.

The trust has around 10 per cent of its assets in A shares, which offer exposure to the Chinese domestic market. Chinese A shares are quoted in the Renminbi currency and traded on the Shanghai and Shenzhen stock exchanges. Chinese H shares are traded on the Hong Kong Stock Exchange and open to international investors.

From June this year, MSCI will begin adding Chinese A shares to its Emerging Markets index. However, only 222 Chinese large-cap A shares will be included, representing around 5 per cent of the total market. But Mr Nicholls believes it is only a matter of time before China makes up a larger percentage of emerging markets and global indices. While he does not invest according to what is included in indices or these possible changes, the inclusion of more A shares in MSCI Emerging Markets index could mean more trading of these shares. And this could boost the trust's holdings.

As of 31 January, the trust had net gearing of 16 per cent consisting of debt and contracts for difference (CFD). Fidelity China Special Situations can also short companies (bet on their share prices falling). Currently the trust's shorting exposure is 8.5 per cent of its NAV.

Fidelity China Special Situations is trading on a discount to NAV of around 11 per cent. The discount to NAV has tightened substantially since July 2015 when it was 23 per cent, which Fidelity says is for reasons including the trust's performance. The trust can buy back shares to control its discount, but its board is not currently planning to do this as it thinks the tightening trend will continue. 

 

Fidelity China Special Situations (FCSS)

PRICE249.pGEARING26%
AIC SECTOR Country Specialists: Asia PacificNAV279.7p
FUND TYPEInvestment trustDISCOUNT TO NAV11%
MARKET CAP£1.37bnYIELD0.5%
No OF HOLDINGS140*ONGOING CHARGE1.16%
SET-UP DATE19/04/2010MORE DETAILSfidelity.co.uk
MANAGER START DATE01/04/2014  

Source: Winterflood Securities as at 26/02/18, *Fidelity International as at 31/01/18

 

Performance

Trust/benchmark1-year share price  return (%)3-year cumulative share price return (%)5-year cumulative share price return  (%)
Fidelity China Special Situations3494183
MSCI China index336492

Source: Winterflood Securities as at 26/02/18

 

Top 10 holdings as at 31/01/18 (%)

Tencent16.7
Alibaba 10.3
China Pacific Insurance4.7
Hutchison China Meditech 3.5
China Life Insurance 2.8
58.com2.2
China Petroleum & Chemical 1.9
Ctrip.com1.9
Noah Holdings1.8
Shangri-La Asia1.7

Source: Fidelity International

 

Sector breakdown as at 31/01/18 (%)

Information technology40.0
Consumer discretionary31.0
Industrials13.8
Financials13.4
Consumer staples7.3
Health care7.0
Energy2.9
Utilities2.2
Real estate1.7
Telecommunication services1.4
Materials1.1

Source: Fidelity International