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Fidelity China Special Situations: August 2022 update

  • 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 currently sees most opportunity in the consumer, technology and industrials sectors
  • It’s been a tough year for Chinese markets, though the trust has performed well over the longer term

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).

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 dedicated China analysts and a smaller companies team. Nicholls draws on the research and insights from these analysts, including regular support 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 to find ideas for the trust. They help to carry out some of the behind-the-scenes research, while he has the final say about 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 recognize 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. 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.

Current investments include Skshu Paint, one of China’s largest paint manufacturers. According to Nicholls, the company continues to take market share from its competitors and generates strong cash flows. Noah Holdings is another – it’s a leading wealth and asset management provider and could benefit from wealth growth in China.

The manager also has the flexibility to invest up to 15% 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 the future, but this increases risk as these companies are less liquid (more difficult to buy and sell) than listed ones. 13.8% of the trust is currently invested in unlisted companies. This includes ByteDance, which owns online platforms such as TikTok, drone manufacturer DJI, and driverless vehicle business Pony.ai.

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-incentivized. We think it’s positive that all Fidelity fund managers are incentivized based on the longer-term performance of their funds. This should align their interests with those of investors.

ESG integration

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. This is not an exclusions-based trust though, which means it has the ability to invest in any sector.

Cost

The trust’s ongoing charge was 1.04% for the 12 months to the end of March 2022. Investors should refer to the latest annual reports and accounts and Key Information Document 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. Our platform fee doesn’t apply if held in a Fund and Share Account.

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. Past performance is not a guide to future returns.

The Chinese stock market has been weak over the past year, with the FTSE China Index falling 17.19%* over the 12 months to the end of June 2022. China has faced headwinds due to Covid-induced lockdowns, supply chain constraints, and regulatory crackdowns on sectors such as technology, property, and education.

Fidelity China Special Situations has failed 27.29% over the past year. The trust uses gearing (borrowing to invest) which amplifies gains in a rising market, but losses in a falling one. This has therefore held back returns over the year. At the time of writing, gearing stands at 26%.

Some of the trust’s growth-focused companies – those that are expected to grow earnings further out in the future – have also been weaker this year. Investors have tended to favor value investing this year, which focuses on companies with share prices deemed to be below their true worth, or which are going through a recovery.

Investments in ADRs (American Depository Receipts) have also held back returns. ADRs represent the shares of foreign companies that can be bought and sold on US markets, but the expectation of greater regulation on these stocks in the US has damaged investor sentiment. Nicholls is comfortable continuing to invest in most of these companies, as they also have shares that can be bought and sold on the Hong Kong market.

Other parts of the trust have performed well though, including the unlisted companies. This includes Pony.ai, an autonomous vehicle company and the first to offer a Robotaxi service to the public in China and California.

Overall, the manager continues to focus on what he believes to be resilient companies that 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 %
Jul 17 –

Jul 18
Jul 18 –

Jul 19
Jul 19 –

Jul 20
Jul 20 –

Jul 21
Jul 21 –

Jul 22
Fidelity China Special Situations PLC 10.45 -2.72 35.08 19.87 -27.29
AIC Investment Trust – China / Greater China 9.75 1.47 34.29 23.42 -26.72

Past performance is not a guide to the future. Source: *Lipper IM to 07/31/2022

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

Fidelity China Special Situations Key Information Document

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