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Fidelity China Special Situations: July 2021 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 fastest growing economies
  • Dale Nicholls sees most opportunity in the consumer, technology and healthcare sectors
  • It’s been a strong year for the trust, more recently helped by the focus on smaller and overlooked companies

How it fits in a portfolio

Fidelity China Special Situations aims to provide long-term growth by investing in Chinese companies of all sizes, with a focus on small and medium-sized companies. The Chinese market is large and diverse, so it’s full of opportunity, and this trust offers patient investors a way to access the long-term growth story of the world's second-largest economy.

The trust is a more adventurous option. A focus on a single emerging market, small and medium-sized companies, the use of derivatives, and a high level of gearing (borrowing to invest to try to boost returns) increases risk and means performance can be volatile. A trust like this should only make up a small portion of a diversified investment portfolio with a long-term outlook.

Please note the share price of investment trusts can trade at a premium or discount to their net asset value (NAV). The Board of this trust recently introduced a new policy to keep its discount below 10%.

Manager

Dale Nicholls, the trust’s manager, joined Fidelity in 1996. He has since focused on Asian markets and quickly took a keen interest in China. He took over management of the Fidelity Pacific Fund in 2003, which invests partly in China as well as other Pacific markets such as Australia and Japan. Nicholls also previously ran an Asian smaller companies fund, providing experience of investing in companies of all sizes. He took over management of Fidelity China Special Situations in 2014.

The manager has the support of a wide range of research resources at Fidelity. The Asian equities team is made up of portfolio managers and analysts based across the region, including 25 dedicated China analysts and a smaller companies team. Nicholls draws on the research and insights from these analysts, including regular conversations and challenge. The team also has good access to company management to enhance their research.

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, while he has the 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.

The trust provides diverse exposure to the Chinese market. Some of the biggest investments 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 with 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.

The manager believes 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 invests in companies that could benefit from these trends, and the consumer, technology, and healthcare sectors make up a large part of the trust.

He also recently increased investments in the materials sector, including some building materials and paint companies. In these areas, some companies are getting squeezed out of the market by competition, so Nicholls is focused on those he believes will be left standing.

The manager also has the flexibility to invest up to 10% of the trust’s assets 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.

9.0% of the trust currently invests in unlisted companies. This includes ByteDance, which owns online platforms such as TikTok, drone manufacturer DJI, and driverless vehicle business Pony.ai. Nicholls has found an increasing number of opportunities in unlisted companies, so the trust’s Board is seeking approval to increase the limit to 15% of the trust’s net assets.

Culture

Fidelity was founded in 1969 and is a global investment manager. The company remains privately owned, meaning its managers can focus on the long-term interests of investors rather than short-term shareholder demands. That’s helped the firm develop an investment-focused culture, where investment ideas are openly discussed and debated, and information is shared amongst the firm’s various teams.

The company's scale means investment teams are well-resourced and fund managers are well-incentivised. We think it's positive that all Fidelity fund managers are incentivised based on the longer-term performance of their funds. This should align their interests with those of investors.

Fidelity’s worked hard to encourage its fund managers to integrate Environmental, Social and Governance (ESG) analysis into their investment processes in recent years. Managers have access to the firm’s proprietary ESG ratings tool and a bank of analysts with ESG expertise. While Nicholls has always focused on corporate governance, he is increasingly focused on environmental and societal issues. He believes ESG factors will ultimately have an impact on a company’s long-term performance, so they should be core to the investment process.

Cost

The trust's ongoing charge was 0.97% for the 12 months to the end of March 2021. 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 investments in smaller and unquoted companies could boost long-term performance, returns are likely to look different from the market at times.

The trust has had a strong year, with its net asset value rising 45.2%. The discount has also narrowed significantly over the year, boosting the share price by 52.2%. Please note that while the trust has experienced strong periods of performance, it’s had weaker ones and can lose money too. Past performance is not a guide to future returns.

Some of China’s largest tech companies, including Tencent and Alibaba, performed well last year, contributing to performance. More recently though, smaller companies and others that had previously been overlooked by many investors have made a comeback and boosted the trust’s performance. This includes Xtep, a leading sportswear brand in China, particularly in running. It’s benefited over the year as people started working out more following Covid-induced lockdowns. It’s also benefited as more Chinese consumers have gradually shifted away from foreign to domestic brands.

More broadly, the trust’s investments in ‘New China’ sectors have helped performance, including consumer, healthcare and tech companies.

It hasn’t all been plain sailing though, and the trust has held some weaker performers, or missed out on gains made by companies not held in the trust. This includes Meituan, a delivery platform. It used to be held in the trust and did well over this time, though the manager sold it after a period of strong performance as he felt it no longer offered as much value. It continued to perform well over the past year though, benefiting from increased demand for online delivery services.

Overall, the manager continues to focus on resilient companies he believes are good at dealing with periods of crises and change. There is a lot of long-term opportunity in the trust, though there are no guarantees over future returns.

Annual percentage growth
June 16 -
June 17
June 17 -
June 18
June 18 -
June 19
June 19 -
June 20
June 20 -
June 21
AIC Investment Trust - China/Greater China 38.8% 14.6% -2.4% 31.3% 56.5%
Fidelity China Special Situations PLC 44.4% 18.4% -7.3% 27.7% 52.2%

Past performance is not a guide to the future. Source: Lipper IM to 30/06/2021.

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

Fidelity China Special Situations Trust 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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