Weak sentiment providing opportunities

Fidelity China Special Situations 19 February 2020 Update
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Fidelity China Special Situations

Weak sentiment providing opportunities

Investment trusts
Chinese equities

19 February 2020

Price

241.0p

Market cap

£1,315m

AUM

£1,756m

NAV*

265.8p

Discount to NAV

9.3%

*Including income. As at 18 February 2020.

Yield

1.6%

Ongoing charge

1.0%

Ordinary shares in issue

545.6m

Code

FCSS

Primary exchange

LSE

AIC sector

Country Specialist:
Asia Pacific – ex Japan

Benchmark

MSCI China

Share price/discount performance

Three-year performance vs index

52-week high/low

253.0p

205.5p

277.5p

226.6p

*Including income.

Gearing

Gross*

23.9%

Net*

19.2%

*As at 31 December 2019.

Analysts

Helena Coles

+44 (0)20 3681 2522

Mel Jenner

+44 (0)20 3077 5720

Fidelity China Special Situations is a research client of Edison Investment Research Limited

Fidelity China Special Situations (FCSS) aims to deliver long-term capital growth, following a bottom-up approach to investing in companies listed in China, and Chinese companies listed elsewhere. The trust marks its 10th anniversary in April 2020 and, since inception, it has generated an annualised NAV total return of 11%. Chinese equities have been relatively out of favour for some time against a backdrop of the US-China trade dispute, Hong Kong political protests and, more recently, the coronavirus. The manager, Dale Nicholls, is finding exciting opportunities at attractive valuations, and continues to focus primarily on smaller companies that can benefit from long-term secular growth trends.

Solid NAV outperformance versus the benchmark since inception

Source: Refinitiv, Edison Investment Research

The market opportunity

China’s GDP growth rate is slowing, and the recent outbreak of the coronavirus is likely to further reduce expectations for 2020. However, the economy is still relatively robust compared to the developed world. Furthermore, the headline GDP growth belies many areas of economic activity that are vibrant, with strong prospects for multi-year high growth. Investors seeking exposure to Chinese equities may benefit from a selective bottom-up approach, with a long-term horizon.

Why consider investing in FCSS?

Dale Nicholls has over 24 years’ investment experience and a successful track record managing the trust since April 2014.

Rigorous, research-driven approach to investing in China, supported by Fidelity’s well-resourced team of analysts based in China and Asia.

Offers direct exposure to China’s continuing growth, with a bias to less well-researched small- and mid-sized companies.

Proactive board manages discount volatility

In June 2019, the board adopted a formal policy aiming to maintain the discount in single digits. FCSS currently trades at a 9.3% discount to cum-income NAV, and the board has been proactive in helping to stabilise the volatility of the discount and the trust’s share price during the coronavirus outbreak. There is scope for the discount to narrow should investor sentiment towards China improve.

Exhibit 1: Trust at a glance

Investment objective and fund background

Recent developments

Fidelity China Special Situations aims to achieve long-term capital growth from an actively managed portfolio made up primarily of securities issued by companies listed in China, and Chinese companies listed elsewhere. It may also invest in listed companies with significant interests in China. Futures, options and CFDs are used to provide gearing, as well as to take short positions.

27 November 2019: Interim results to 30 September 2019 – NAV TR -5.9% versus benchmark TR -3.3%, share price TR -6.0%.

5 June 2019: Adoption of formal single-digit discount control policy.

5 June 2019: Annual results to 31 March 2019 – NAV TR -5.3% versus benchmark TR +0.9%, share price TR -0.3%.

5 June 2019: FY19 dividend increased by 10% to 3.85p per share.

Forthcoming

Capital structure

Fund details

AGM

July 2020

Ongoing charges

1.0% end-September 2019

Group

Fidelity International

Annual results

June 2020

Net market gearing*

19.2%

Manager

Dale Nicholls

Year end

31 March

Annual mgmt fee

Variable: 0.7–1.1% of net assets

Address

Beech Gate, Millfield Lane,

Lower Kingswood, Tadworth, Surrey, KT20 6RP

Dividend paid

July 2020

Performance fee

None

Launch date

April 2010

Trust life

Indefinite

Phone

0800 41 41 10

Continuation vote

No

Loan facilities

US$150m revolving

Website

www.fidelity.co.uk/chinaspecial

Dividend policy and history (financial years)

Share buyback policy and history (financial years)

Although focused on capital growth, FCSS pays an annual dividend, which has been increased every year since its inception.

FCSS has authority to buy back up to 14.99% and allot up to 10% of its shares in issue. A formal single-digit discount control policy was adopted in June 2019.

Shareholder base (as at 31 January 2020)

Portfolio exposure by market cap (as at 31 December 2019)

Top 10 holdings (as at 31 December 2019)

Portfolio weight %**

Benchmark weight (%)

Active weight vs benchmark (%)

Company

Sector

31 December 2019

31 December 2018***

Tencent

Communication services

13.1

14.9

13.0

0.1

Alibaba

Consumer discretionary

12.9

9.5

16.8

(3.9)

China MeiDong Auto

Consumer discretionary

6.7

N/A

0.0

6.7

China Pacific Insurance

Financials

4.2

4.9

0.6

3.6

China Life Insurance

Financials

3.2

2.9

1.0

2.2

Hutchison China Meditech

Healthcare

2.5

2.7

0.1

2.4

Noah

Financials

2.3

2.2

0.1

2.2

Trip.com

Consumer discretionary

2.2

N/A

0.7

1.5

Kingsoft

Information technology

2.0

N/A

0.1

1.9

WuXi AppTec

Healthcare

2.0

N/A

0.1

1.9

Top 10 (% of portfolio)

37.1

36.9

Source: Fidelity China Special Situations, Edison Investment Research, Bloomberg, Morningstar. Note: *Gearing net of short positions. **Adjusted for gearing and index hedges (holdings data may differ from non-adjusted data displayed in FCSS’s factsheet). ***N/A where not in end-December 2018 top 10.

The fund manager: Dale Nicholls

The manager’s view: well-positioned portfolio

Nicholls believes that investor sentiment towards China has been dented over the past 18 months by media headlines relating to the US-China trade dispute and, more recently, the coronavirus outbreak. On the latter, he believes that the economic impact may be greater than that associated with the SARS virus in 2003, and the recovery period could be more drawn out. The Chinese government has already responded with supportive economic policies, and it may introduce further measures to help underpin the economy. Nicholls believes that the economic impact of the coronavirus will differ from sector to sector, and that some may emerge stronger. For example, online activities should fare relatively well, while there may be a boost for the healthcare and insurance sectors. He believes the trust is well positioned to benefit from these trends, and is closely monitoring how companies navigate this difficult period.

Looking longer term, Nicholls notes that China’s GDP growth rate is on a slowing trend, but is nevertheless relatively robust compared to developed economies. Furthermore, he explains that the headline figures belie many areas of very strong secular growth, mostly within domestic sectors. He believes domestic consumption will be the future driver for the economy, and key trends include consumers trading up in goods and services as incomes rise. He also finds leading technological innovation among Chinese companies across a broad range of sectors, including financial services and healthcare.

The portfolio

Chinese equities are relatively out of favour and global portfolios are underweight this market. This has presented the manager with opportunities to add to a number of existing positions where he feels stocks have been oversold relative to their long-term prospects. These include online travel agent, Trip.com. The company has a dominant market position, which Nicholls believes to be unassailable in the mid- to high-end segment. In his view, although the environment for travel is bleak in the short term, prospects for long-term structural growth are very bright, with just 13% of Chinese nationals owning a passport.

The political discontent in Hong Kong has been punitive for its retail sector, especially the luxury segment, and Nicholls added to jewellery retailer Luk Fook. Although the company’s origins are in Hong Kong, its growth has been driven by China, which accounts for over half of its profits. The share price has fallen to levels where the manager sees compelling long-term value and, in his view, no longer ascribes value to its long-established Hong Kong business.

Nicholls also added to the portfolio’s holding in WuXi AppTec (WuXi), a leading contract research organisation (CRO) for the pharmaceuticals, biotech and medical device industries. The company is the largest CRO in Asia and one of the leading players globally. The manager believes increasing demand for CROs is a global structural trend, and that WuXi is particularly well-positioned to benefit given its strong track record in drug research, and established long-term relationships with its customers (which include all of the top 20 global pharmaceutical companies by 2017 revenues).

The manager topped up the position in internet data centre company, 21Vianet. The company is the leading carrier-neutral player in China, providing hosting, cloud and business virtual private network (VPN) services. Nicholls notes that China’s internet infrastructure industry is among the fastest growing in the world, underpinned by increasing consumer usage of the internet via mobile phones, and demand for cloud and IT services from corporates. 21Vianet added Alibaba as a corporate client last year, which reinforced the manager’s positive view on the company’s competitive advantages.

The portfolio is predominantly domestically focused, with around 90% of revenues for the underlying holdings derived from Greater China (China, Hong Kong, Macau and Taiwan), and just 1.5% exposed to the US. During Q419, the manager shifted the portfolio, becoming slightly more defensive, including reducing net gearing from 22% to 19% by end-December 2019. More recently, in response to the increased uncertainty for near-term market prospects caused by the coronavirus, he has also used derivatives to add downside protection to the portfolio.

Performance: Solid track record

As shown in Exhibits 3 and 4, FCSS has a solid performance track record, and its NAV total return has outpaced its benchmark over most periods shown, with the exception of three years. Over that period, the performance of the MSCI China Index has, at times, been led by a relatively narrow set of large-cap names. FCSS’s focus on investing with a long-term horizon, and with a bias in favour of small- and mid-cap companies, means the trust’s returns can diverge meaningfully from the index. FCSS has significantly outperformed the MSCI China Small Cap Index over all periods shown.

Exhibit 2: Five-year discrete performance data

12 months ending

Share price
(%)

NAV
(%)

MSCI China
(%)

MSCI China Small Cap (%)

MSCI World

(%)

CBOE UK All Companies (%)

31/01/16

(9.4)

(4.7)

(16.5)

(6.5)

1.1

(5.3)

31/01/17

49.2

42.3

39.5

30.0

32.8

20.9

31/01/18

45.0

40.6

43.8

14.0

11.9

11.3

31/01/19

(21.5)

(20.3)

(13.3)

(13.9)

1.6

(3.9)

31/01/20

13.2

9.2

5.8

(4.9)

18.2

10.5

Source: Refinitiv. Note: All % on a total return basis in pounds sterling.

Exhibit 3: Investment trust performance to 31 January 2020

Price, NAV and benchmark total return performance, one-year rebased

Price, NAV and benchmark total return performance (%)

Source: Refinitiv, Edison Investment Research. Note: Three-, five- and SI (since inception) performance figures annualised. Inception date is 16 April 2010.

Exhibit 4: Share price and NAV total return performance, relative to indices (%)

 

One month

Three months

Six months

One year

Three years

Five years

SI

Price relative to MSCI China

0.2

2.9

(0.5)

7.0

(2.3)

13.4

27.5

NAV relative to MSCI China

1.7

2.2

0.9

3.3

(7.2)

8.0

41.1

Price relative to MSCI China Small Cap

0.2

8.1

8.5

19.0

38.0

53.6

116.2

NAV relative to MSCI China Small Cap

1.8

7.3

10.1

14.8

31.1

46.3

139.2

Price relative to MSCI World

(4.0)

2.5

(3.8)

(4.2)

(4.1)

(3.4)

(15.5)

NAV relative to MSCI World

(2.6)

1.8

(2.4)

(7.5)

(8.9)

(8.0)

(6.5)

Price relative to CBOE UK All Companies

(0.7)

4.2

(3.0)

2.5

9.1

28.9

23.9

NAV relative to CBOE UK All Companies

0.8

3.5

(1.6)

(1.1)

3.6

22.7

37.1

Source: Refinitiv, Edison Investment Research. Note: Data to end-January 2020. Inception date is 16 April 2010. Geometric calculation.

Exhibit 5: NAV total return performance relative to benchmark over five years

Source: Refinitiv, Edison Investment Research

Valuation: Board promotes share price stability

FCSS is currently trading at a 9.3% discount to its cum-income NAV, which is below its three-year average of 11.4%. In June 2019, the board adopted a formal discount control policy, which seeks to maintain the discount in single digits, in normal market conditions. It has the authority (renewed annually) to repurchase up to 14.99% of FCSS shares in issue, which it recently exercised to stabilise the discount and share price volatility during the coronavirus outbreak. As shown in Exhibit 6, this has helped restore the discount to within its recent single-digit range. Investor sentiment towards China has been weak since the onset of the US-China trade dispute some 18 months ago. Should this improve, there is scope for FCSS’s discount to narrow.

Exhibit 6: Share price discount to NAV (including income) over three years (%)

Source: Refinitiv, Edison Investment Research

General disclaimer and copyright

This report has been commissioned by Fidelity China Special Situations and prepared and issued by Edison, in consideration of a fee payable by Fidelity China Special Situations. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

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Frankfurt +49 (0)69 78 8076 960

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Fidelity China Special Situations and prepared and issued by Edison, in consideration of a fee payable by Fidelity China Special Situations. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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