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Fidelity China Special Situations: July 2020 update

Senior Investment Analyst Kate Marshall shares our analysis on the manager, process, culture, cost and performance of Fidelity China Special Situations PLC.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

  • This trust aims to benefit from the long-term growth potential of smaller businesses based in one of the world's most rapidly growing economies
  • Dale Nicholls sees most opportunity in the consumer, technology and healthcare sectors
  • A focus on small businesses held back recent performance, but longer-term returns remain strong

How it fits in a portfolio

This is an adventurous investment trust that aims to provide long-term growth by investing in China. The Chinese market is large and diverse, so it offers plenty of opportunity, and this trust offers patient investors a way to access the long-term growth story of the world's second-largest economy. That said, a focus on a single emerging market, a bias towards small and medium-sized companies, the use of derivatives, and a high level of gearing (currently 21%) increases risk and means performance can be volatile. A trust like this should only make up a small portion of a diversified investment portfolio.

Manager

Dale Nicholls took over management of Fidelity China Special Situations in 2014. He joined Fidelity in 1996 and soon took a keen interest in the Chinese market. Nicholls later took over the Fidelity Pacific Fund, which invests partly in China but also in other Pacific markets such as Australia and Japan. He also previously ran an Asian smaller companies fund, providing him with experience of investing in companies of all sizes.

Nicholls has the support of a wide range of resources at Fidelity, including the Asia team. This includes a huge pool of analysts, whose research and insights he can freely draw on. They are based across the Asia Pacific region, meaning they have good access to company management.

Process

Nicholls makes use of Fidelity’s vast pool of analysts in order to find ideas for the trust. They help to carry out some of the behind-the-scenes research, and Nicholls has final say over what companies make it in and out of the portfolio.

The manager focuses on companies he thinks have good long-term growth prospects, but where this potential has been underestimated by other investors. This provides the opportunity to invest in shares at a price that could later rise once others recognise this potential, and if the company continues to generate growth.

Currently, some of the biggest investments in the trust are in larger Chinese businesses such as tech firms Tencent and Alibaba. But overall the trust has a bias towards higher-risk small and medium-sized businesses that may have superior growth potential. Less research tends to be carried out on these businesses, which gives Nicholls and his team the chance to spot opportunities before they grow into larger firms.

Nicholls thinks the growth of China's middle class and an increasing focus towards domestic consumption will be key drivers of the economy in the coming years. He mainly invests in companies that could benefit from these trends, and the consumer, technology, and healthcare sectors make up a large part of the trust.

The manager also has the flexibility to invest up to 10% of the trust in companies that aren't currently listed on a stock exchange (unquoted companies). These are often younger businesses that could grow quickly in future, but this increases risk as these companies are less liquid (more difficult to buy and sell) than listed ones.

The trust currently invests in six unquoted companies, which make up 6% of the portfolio. This includes ByteDance, which owns online platforms such as TikTok, Didi Chuxing, which owns a ride-hailing app similar to Uber, drone manufacturer DJI, and driverless vehicle business Pony.ai.

Culture

Fidelity International began life in 1969 as part of US-based Fidelity Investments, one of the largest asset managers in the world. It was spun off in 1980 and remains a separate, private business owned by its employees. We think that’s a good thing as it means the company can focus on the long-term and encourages employees to commit to the business.

Fidelity International is a large firm in its own right and one of the best resourced asset managers around. It has a bank of several hundred research analysts, which are used as a central resource by fund managers from across the business. Managers don’t have to agree with or even use the analysts’ research, but it is undoubtedly a valuable resource available to them.

Cost

The trust's ongoing charge was 0.99% for the 12 months to the end of March 2020. Investors should refer to the latest annual reports and accounts and Key Investor Information for details of the risks and charging structure.

If held in a SIPP or ISA the HL platform fee of 0.45% (capped at £200 for a SIPP and £45 for an ISA) per annum also applies.

Performance

Fidelity China Special Situations has performed better than the broader Chinese stock market since Nicholls took over in April 2014. Performance has been volatile at times though, given the trust's focus on smaller businesses. While this bias towards smaller companies, and investments in unquoted companies, could boost long-term performance, returns are likely to look quite different from the benchmark at times.

According to the most recent annual results, the trust's NAV (Net Asset Value) fell 5.9% over the year to 31 March 2020. Its share price fell 6.5% as the discount widened (at the time of writing the discount stands at 8.4%). The Chinese stock market fell 1.0% over the same period. It's worth noting that since the end of March, the trust has outperformed the market, but this is over a short timeframe. Past performance isn't a guide to future returns.

Like most global markets, China has been impacted by the outbreak of Covid-19. But, as the first economy going into the pandemic, and the first to experience some sort of recovery, China's stock market hasn't been as severely impacted as many other global markets.

Smaller companies didn't hold up as well as larger businesses over the 12-month results period, which is often the case during periods of uncertainty and when investor sentiment is weaker. This impacted the trust's performance, and explains most of its underperformance over this time.

Some of the trust's investments in companies that rely on consumption held up relatively well. This includes China Meidong Auto Holdings, which focuses on the premium car segment in China, with brands such as BMW, Porsche and Lexus.

Some investments in companies that provide tech solutions also did well. Alibaba and Tencent, which offer services spanning e-commerce, online gaming, cloud computing and finance, benefited throughout the recent outbreak. As well as tech, Nicholls thinks areas such as healthcare and life insurance will see ongoing interest as we gradually move into a post-virus world.

Annual percentage growth
Jun 15 -
Jun 16
Jun 16 -
Jun 17
Jun 17 -
Jun 18
Jun 18 -
Jun 19
Jun 19 -
Jun 20
Fidelity China Special Situations PLC -3.5% 44.4% 18.4% -7.3% 27.7%
FTSE China -8.5% 30.3% 17.4% -2.7% 17.6%

Past performance is not a guide to the future. Source: Lipper IM to 30/06/2020

Find out more about Fidelity China Special Situations Trust, including charges

Fidelity China Special Situations Key Investor Information

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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