Fidelity China Special Situations

Transcription

1 Material produced by Kepler Trust Intelligence should be considered a marketing communication, and is not independent research. Fidelity China Special Situations Summary Fidelity China Special Situations is a 1.5bn portfolio of Chinese equities, structurally tilted to the domestic Chinese economy, in particular small and mid caps in the consumer and technology industries. It has some exposure to A-Shares, stocks listed in China which are being slowly incorporated within mainstream MSCI indices. The trust has structural gearing worth 1 of NAV and a track record of maintaining borrowings closer to 25. It holds some private companies in its portfolio. stocks, which the fund is overweight over 2, and industrials, to which the fund has a 9 overweight. This is a result of the manager s aim to capture the growth in the new China the domestic, consumption-led growth that is being directed by the Communist Party as it attempts to break out of the middle income trap. 6 4 : Sector exposure The trust has outperformed over the medium term and managed to keep pace with the 217 rally despite being underweight the large stocks that led the charge. A yield of 1 is not high but has been growing at a significant pace. 2 IT Consumer Disc Industrials Financials Consumer Staples Health Care Energy Utilities Real Estate Telecomms Materials The trust has traded on a double-digit discount since late 212, when the emerging markets region fell out of favour. The board has been targeting closing the discount through buybacks. Portfolio Fidelity China Special Situations has a diversified portfolio of over 15 stocks. It is benchmarked to the Index, but has a structural tilt towards mid and small caps. In fact, 2 of the trust is in companies with a market cap of under $1bn, to which there is effectively no exposure in the index : Market cap exposure /Kepler Partners The trust invests across the different types of shares included in the : HK-listed stock, including H-Shares and Red Chips, US-listed ADRs and a small allocation to B-Shares, which are listed in China but denominated in foreign currencies. It also has an 11 allocation to A-Shares. Until this month (May 218) A-Shares were not included in the main MSCI Indices and so fell out of the universe of many investors, so this whole allocation was off-benchmark. Over time this will change, bringing greater liquidity to the onshore market and greater investor attention. Manager Dale Nicholls also invests in companies listed in other markets if they derive significant revenues from China. In practice this means small allocations to Taiwan, Singapore, Australia and companies listed on the UK AIM market. 6 : Regional / Share class exposure 4 >1bn 5-1bn 1-5bn <1bn 2 The largest sector exposure is to information technology (IT) at 4, but this is in line with the weight in the. The key differentiating exposures are to consumer discretionary China A-Shares China B-Shares China H-Shares China Red Chips Other HK-listed stocks Singapore USA Taiwan Australia Other

2 The focus on the secular growth in middle-class consumption means the portfolio is highly exposed to the domestic economy. This comes through in healthcare as well as consumer discretionary exposures. This is balanced by a significant underweight to financials, a result of the trust avoiding the large banks, which are more beholden to the health of the economy and companies as a whole rather than secular consumption trends, and remain an arm of the government to a greater or lesser extent. Similarly, Dale avoids state-owned enterprises as a rule, although he is looking for those that might benefit from the rebalancing towards consumption. It is also worth noting that the technology exposure may be equal with the index s, but given the trust is underweight both Tencent and Alibaba, it is ipso facto overweight the rest of Chinese tech. Some of the company s biggest winners have come from technology, including in Q1 218 online retailer Vipshop, cloud computing service Chinasoft and online recruitment service 51job. Furthermore, the trust has held Alibaba since it was a private business, benefiting from the record-breaking IPO in January 214 and price appreciation since then. Dale remains focused on finding the next Alibabas and Tencents, although he holds large positions in both, at significant underweights. caps led the way, in the tech sector especially, as money flooded in from global investors, much of it either passive or semi-active. Tencent and Alibaba make up almost 3 of the index on their own, and attracted a lot of the money (along with South Korean Samsung and Taiwanese TSMC). The trust had a slight underweight to tech, which hurt it as it did not hold the right stocks in that sector. It made good money on Tencent and Alibaba, but was underweight. There were also some issues with the picks in this sector; for example, online retailer 58.com had a dreadful year (which it made up for in 217). The trust was also not positioned for the sharp rally in cyclicals. It was underweight energy, which rallied hard, and although overweight consumer cyclicals, stock selection hurt there. Large caps did better than small and mid caps in 217, but the fund managed to keep pace with the index despite its tilt to SMIDs. 5 Fidelity China Special Sits: Discrete calendar year returns Returns It was well-documented that Fidelity China Special Situations initially struggled following its launch in 21, but performance has improved over recent years particularly since Dale became manager in Over five years to the end of March 218, the trust has delivered NAV returns of 29 compared to 186 from the index. Small caps have underperformed at an index level over this period as a whole, but mid caps have returned circa 125. Fidelity China Special Situations: performance versus indices 3 2 from to Dividend Fidelity China Special (NAV) Fidelity China Special (Price) Small Cap The trust is primarily focused on capital growth and its yield is just 1; however, dividend growth over five years has been 27 p.a. This has been boosted by revenue per share growing by 24 p.a. Having paid a covered dividend in each year since launch 1 : Annual Dividends Fidelity China Special Sits (NAV) Fidelity China Special Sits (Price) Small Cap (pence) The large majority of its relative outperformance was generated in 213 to 215. In 216 the trust lagged slightly and in 217 performed in line with the index. During this period China rallied hard, leading the emerging markets region as a whole. Large

3 (its 217 dividend cover was 1.17x), the board has also amassed revenue reserve cover of.7x the total 217 dividend. As such, despite the trust s low yield, Fidelity China Special Situations has generated more income for shareholders over the past three years than JPMorgan Chinese, which currently yields.55. A policy change that took effect from 1 April 217 sees 75 of costs and fees taken from capital rather than 5 as previously. This should see an increase in the income return relative to capital return (although the total shareholder return will be the same). Investment trusts must distribute 85 of net income as dividends, so the yield will rise. Peer group The fund has the highest Sharpe ratio (a measure showing risk adjusted return) out of all the open- and closed-ended China specialist funds over five years, and the only one over one. This is thanks to it the highest alpha over that time against the, although as we have discussed this has to be seen in the light of the fund allocating extensively to small and mid caps, and the tracking error is high. The R-Squared (which shows how correlated to the benchmark returns are) is 8, so the benchmark exposures are clearly very important to returns, although it has to be said this is one of the lower numbers in the peer group, emphasising how much of the trust is invested off-benchmark. Management Dale took control of the fund in April 214 from star manager Anthony Bolton, who ran it from its launch. He is supported by a large team, based in Hong Kong, including 23 analysts among whom 12 are dedicated to solely Chinese equities. The rest consider China in a regional context, and between them the team covers around 97 of the index, meeting each company and refreshing the rating on it every 9-12 days. Each analyst tends to be focused on a given sector or sectors, with a formal remit to cover 25-3 stocks and informal coverage of a wider range. The team also covers the CSI 3, of which about 5 is regularly updated. It focuses heavily on face-to-face meetings, averaging around four meetings every day. As well as more frequent communication on an ad hoc basis, the team meets every two weeks for a formal stock discussion and works around a from scratch -built research platform that Fidelity recently completed, reputed to have cost around $2m, which allows analysts to filter Fidelity research covering companies going back over two decades. NAME PEER GROUP OF CHINA SPECIALIST FUNDS INCEPTION DATE MANAGER NAME Fidelity China Special Ord 19/4/21 Dale Nicholls Royal London/Henderson China Opportu Pen Sanlam/Invesco Perp HK&China 6 Life Matthews Asia Funds China Sm Coms A Acc Baillie Gifford Greater China A Acc 6/4/26 Charles Awdry; May Ling Wee; 4/3/1998 Mike Shiao;Lorraine Kuo; 29/2/212 21/5/29 Kenichi Amaki;Tiffany Hsiao; Mike Gush;Sophie Earnshaw; SE/Jupiter China Pen 3/3/21 Ross Teverson Janus Henderson Hrzn China X2 Matthews Asia Funds China Div A Acc 25/1/28 JPMorgan Chinese Ord 19/1/1993 Fidelity China Consumer A Acc Charlie Awdry;May Ling Wee; 31/1/213 Yu Zhang;Sherwood Zhang; 14/9/211 Hyomi Jie Howard Wang;Rebecca Jiang;Shumin Huang; Emerson Yee Shun Yip; PRIMARY PROSPECTUS BENCHMARK GR MSCI AC Zhong Hua GR MSCI AC Zhong Hua NR Small Cap NR MSCI Golden Dragon NR GBP NR GBP NR NR EUR GR NR GBP ALPHA 5 YR (QTR-END) RISK SHARPE RATIO 5 YR (QTR- END) RISK TRACKING ERROR 5 YR (QTR-END) RISK R-SQUARED 5 YR (QTR- END) RISK CE OE OE OE OE OE OE OE CE OE OPEN OR CLOSED ENDED

4 Gearing The manager can gear up to 3 if he sees fit, and has borrowed extensively through his tenure. There is structural gearing through a $15m loan at a rate of 3.1. This currently expires in February 22 and amounts to 1 of NAV. Dale can also use CFDs to further gear. of NAV : Gearing From to Fidelity China Special Sits Charges The trust has an ongoing charges figure (OCF) of There is a performance fee equal to 15 of the outperformance against the index over a one year period, subject to a 2 hurdle rate. This fee is capped at 1 of the average value of assets at month end during the year and outperformance above this cap is not carried forward. There is a high watermark, so if the company underperforms, it must catch up before any further performance fee is payable. No performance fee was payable for the year ended 31 March 217. The OCF is lower than JPMorgan Chinese, the other specialist China trust, but the KID ROY is slightly higher, at 2.74 compared to Throughout Dale s tenure the trust has remained highly geared and was close to its limit through 217. This year gearing has come down from 28 to 2, reflecting the rise in valuations last year and therefore more caution from the manager. Discount The trust traded on a discount up to the high teens in 215 and 216, thanks to investor aversion to China. However, through 217 investor sentiment changed and the discount significantly narrowed. This was aided by a share buyback programme. No fixed level is in place for when the board does buy back shares, though in practice it has been with the discount between 14 and 15. The last buybacks were in September and November 217. As the froth has come off the Chinese market this year the discount has trended back out towards this number, but it now remains under 14. : Discount / Premium From to Fidelity China Special Sits

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