Fidelity China Special Situations (FCSS) invests in a diversified portfolio of Chinese equities, seeking exposure to higher-quality companies, primarily in faster growing, consumer-orientated areas of the economy. FCSS provides actively managed exposure to the Chinese market, following a bottom-up investment approach, unconstrained by index weightings, and currently has no holdings in banks or property, which are considered to be higher-risk sectors. FCSS has achieved a 14.5% pa NAV total return since its launch in April 2010, and its performance is considerably ahead of the MSCI China index and the world market over three and five years.
The manager follows a bottom-up investment approach to maintain a diversified portfolio of 130-140 holdings, with a bias to small- and mid-cap stocks, which tend to be under-researched and hence more frequently mispriced. There is a focus on faster growing, consumer-orientated companies with robust cash flows and capable management teams. Fidelity analysts provide in-depth stock coverage, with site visits and company meetings considered essential to the process, and risk management is viewed as a priority. FCSS has US$150m of borrowing and uses futures, options and contracts for difference (CFDs) to add gearing, as well as to take short positions. Unlisted securities may comprise up to 10% of the portfolio.
Despite valuations rising over the last year, China’s ‘H’ share market trades at a 7.2x forward P/E multiple compared with 15.6x for the world market. Corporate earnings growth remains strong, reflecting China’s superior GDP growth. Historical market volatility provides grounds for caution, but investors with a long-term view may be attracted by China’s robust growth and discounted market valuation. The inclusion of China ‘A’ shares in MSCI emerging market indices from June 2018 may further encourage interest. A fund with a bottom-up approach, focusing on faster growing segments of China’s economy, may appeal as a route to gain exposure.
FCSS’s share price discount to NAV cum income has followed a narrowing trend for more than one year, moving from 19.5% in July 2016 to 14.9% currently, which compares to its 11.8% five-year average. FCSS has traded at a premium as high as 13.2% since its launch in 2010, suggesting significant scope for further narrowing. A reallocation of expenses will raise the proportion of revenue returns from FY17, resulting in higher dividend distributions than otherwise (see page 7).