Fidelity China Special Ord FCSS

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1 Page 1 of 7 Morningstar Research Report Text as of 01/08/2017, Data as of 27/06/2018 Morningstar Benchmark MSCI China NR USD Morningstar Category TM China Equity Last Closing Price GBP Last Closing NAV GBP Discount/Premium % Latest Published NAV Latest Published NAV Date 26/06/2018 Traded Currency GBX Yield 1.45 Dividend Frequency Annual Total Assets Mil 1,939.5 Net Assets Mil 1,516.2 Market Cap Mil 1,327.7 Net Gearing % 27 Avg Daily Shares Traded Mil (3 month) 0.85 Inception Date 19/04/ k 80k 60k 40k 20k 10k Returns Price NAV Category Index 4k 10 Discounts Premium 0 Discount -10 Average Line YTD Performance % Fund Price Fund NAV /- Category /- Benchmark Morningstar Analyst: David Holder, Senior Analyst The conduct of Morningstar's analysts is governed by Morningstar's Code of Ethics, Securities Trading and Disclosure Policy, and Morningstar Manager Research Integrity Policy. For information regarding conflicts of interest, please click Executive Summary People: Dale Nicholls' management has bedded down since his appointment here in April He brings extensive experience albeit mostly within the Asia-Pacific sphere. In addition, he has substantial smaller companies experience, which is relevant here. Parent: Fidelity boasts a huge analyst team, which facilitates its predominantly bottom-up-investing ethos. Board: The board comprises six members including John Ford, who, as a Fidelity employee, is nonindependent. This continual appointment of a Fidelity representative on the board looks increasingly anomalous within the investment trust sector. Process: Nicholls builds his portfolio from the bottom up and is likely to have a bias to underresearched small and midsize companies. He focuses on cash flow generation, good longterm growth prospects, and strong management teams. Performance: Performance over Nicholls' tenure has been good when compared with peers, the MSCI China Index, and Chinese smaller companies. He has also demonstrated longterm outperformance with his Pacific fund, which has a material allocation to China. Fees: Both the annual management fee and the performance fee have been reduced since the fund's inception, but the combination of the two elements, when triggered, can lead to investors paying high levels of fees when compared with peers. Role in Portfolio Niche. This fund is suitable for those investors seeking dedicated exposure to China and the Greater China region. The combination of exposure to inherently volatile markets, unlisteds, and the effects of gearing can lead to a bumpy ride for investors. For most investors, we would suggest a broader Asian fund that can allocate to and from China as a more appropriate way to invest within the region. Morningstar Opinion 01 Aug 2017 Whilst Dale Nicholls' tenure here is relatively short (April 2014), his investment experience with Chinese equities goes back to September 2003, when he began managing the Fidelity funds Pacific fund, which can invest up to a third of the portfolio in this area. The investment process is entirely bottom-up, with Nicholls allowed significant latitude to deviate from the index at the stock and sector levels. He carries out around 500 company meetings per year and draws heavily upon the wider and extensive resource available to him at Fidelity in the region and beyond. He has been at Fidelity since 1996 and is thus well positioned to use its global research capability. The China-focused team now numbers 23. It has steadily grown over the recent past, having previously suffered staff turnover as the local equity market develops and attracts further external entrants, as well as the existing and burgeoning local brokerage groups. Nicholls can also draw upon a dedicated small-cap analyst, which is salient given the small- and mid-cap bias within the portfolio. At the 2016 annual general meeting, shareholders approved an increase in the limit of unlisted investments to 10% from 5%, and positions here include Shanghai Yiguo E- commerce, Aurora Mobile, Didi Chuxing, and China Internet Plus, which account for around 4% of the portfolio. A further differentiator is that Nicholls can short indexes for portfolio hedging and individual stocks where the valuations are elevated and businesses are structurally flawed with poor management. This element is again modest at around 4%, but it is one we have seen introduced in other Fidelity trusts, notably Asian Values. We await evidence of the long-term effectiveness of this element of the portfolio. The fees that investors pay is one area we feel could be significantly improved. The management fee is 1%, with a performance fee levied of 15% on any net asset value outperformance of more than 2% above the MSCI China Index (capped at 1% of net assets). Whilst there are some caveats, as discussed later, in our opinion, the base management fee should be set materially lower to compensate. In fiscal-year 2016, for example, total fees, including performance fees, reached 2.2%. There is also a question as to the suitability of the reference index, which, given the multi-cap nature of the portfolio, is not representative of the large-cap-orientated MSCI China Index. Aside from our views on the fees levied here, we think that the fund has considerable merit for investors seeking access to this dynamic and increasingly relevant economy. There will be bumps along the way given the structure of the portfolio and the nature of the market, but we feel that Nicholls is a good fit for this fund given his experience in the region and his use of the substantial regional analyst cohort. In recognition of these factors and his promising start, we are upgrading the to Bronze from Neutral.

2 Page 2 of 7 Morningstar Research Report Text as of 01/08/2017, Data as of 27/06/2018 People Manager Dale Nicholls Manager Start 01/04/2014 Avg. Manager Tenure 4.2 Years Other Funds Managed Fidelity Pacific A-Dis-USD Dale Nicholls' tenure here began on 1 April He is part of the Asian equities team at Fidelity. Until the end of 2013, he was based in Singapore, running Fidelity Pacific; at the start of 2014, he relocated to Hong Kong to allow a smooth transition with previous fund manager Anthony Bolton. Nicholls has been with Fidelity since 1996, joining after a two-year spell at Bankers Trust in Tokyo. Until 2003, his specialty was Japanese equities; since then, he has managed a range of Asia-Pacific mandates, including Fidelity Funds Asian Smaller Companies and regional and China mandates. Ahead of his appointment here, he gave up running the smaller companies fund to ensure he has the appropriate amount of time to focus here, but he's still in charge of the GBP 1.3 billion Fidelity Pacific. This is Nicholls first time managing a closed-end fund, and concepts such as gearing and board involvement were initially new to him. Although Fidelity's Asian (ex-japan) investment team of 100-plus is experienced and stable, the China team of 23 including research specialists has seen some turnover, although it has grown from 15 personnel in He can also use a number of outside firms to undertake additional research if necessary. Parent Fund Advisor Domicile Website FIL Investment Management (Hong Kong) Ltd UK Fidelity Worldwide Investment has gradually become more autonomous from its US namesake through the years, most recently in 2013 when it ceased using Fidelity's US-based analysts as its primary resource for North American equity research. Fidelity Worldwide now houses approximately 20 of its own US equity analysts at its London headquarters. Well-resourced fundamental research has always been where Fidelity seeks to stand out. In addition to a well-staffed London office, Fidelity Worldwide has more than 200 analysts/fund managers spread across Europe and Asia. Analysts can elect to remain career analysts or attempt to become fund managers. The relatively short in-house tenure of analysts has probably dictated Fidelity's bonus structure, which rewards stock-picking based on one- and two-year time horizons; that's shorter-term than we like to see. We also think fees could be lower on some of the firm's bigger funds, particularly within fixed income, to reflect the economies of scale Fidelity has in managing a large pool of assets for investors. Despite the fees and remuneration structure, the quality of funds across the Fidelity range is stronger than many comparably sized peers, as evidenced by the large number of funds rated by our analysts across the major asset classes of equity, bond, and balanced sectors. Board of Directors Tender Offer Buyback Authorization No Yes The board of six has an average tenure of approaching five years and meets formally four times a year with regular trips to Asia. Somewhat archaically, Fidelity has continual representation on the board, currently in the form of newest appointment (July 2016) John Ford, who is Fidelity International's Global CIO. The longest-tenured members are Nicholas Bull, the chairman who brings corporate finance experience in London and Asia, and The Hon. Peter Pleydell-Bouverie, who brings extensive regional investment experience for family and charitable trusts, having previously worked at Kleinwort Grieveson Investment Management and latterly at Fidelity International until Aside from John Ford, the most recent appointment was Vera Hong Wei, who has broad experience in investment management and Chinese finance including the central bank, commercial bank, and asset management sectors. The remaining members are Elisabeth Scott and David Causer. Scott was MD for Schroders in Hong Kong until 2008 and chairman of the Hong Kong Investment Funds Association. Causer is a qualified chartered accountant and has held senior management positions in companies such as Merrill Lynch. Overall, the board brings a range of relevant experience here. Two board members serve on other investment trust boards; however, only four members are shareholders, which could be improved upon as we like to see board members' interests aligned with those of shareholders.

3 Page 3 of 7 Morningstar Research Report Text as of 01/08/2017, Data as of 27/06/2018 Process: Investment Approach Investment Objective: To achieve long-term capital growth through investments in a diversified portfolio consisting primarily of securities listed in China or Hong Kong and Chinese companies listed on other stock exchanges. Hedging Policy Tactical Use of Cash NULL No Nicholls focuses on stock specifics and will construct the portfolio with a contrarian tilt that has a bias towards small and medium-size companies that remain typically underresearched in the region. To this effect, Nicholls will look at companies from a USD 200 million market cap, as they attract more widespread broker attention once they reach USD 500 million. Nicholls has at his disposal access to the full extent of Fidelity's extensive regional and wider resource, which facilitates regular company contact including management and company visits as well as competitor and sector analysis. In particular, Nicholls is looking for three key features within a stock: the potential for growth, cash generation, and management quality. Aside from the above, Nicholls also looks at returns on capital, the barriers to entry within an industry, and the competitive advantages that a company may have. He places great emphasis on meeting companies. He himself carried out some 500 annual meetings, and he draws heavily on the local analysts in Hong Kong and China. Stocks are sold on reaching a price target, if concerns arise about the company's fundamentals, or if management fails to execute on its plans. Formal guidelines include relative sector and stock positions of 30% and 3%, respectively, although Nicholls is not forced to hold any stock if it does not meet his investment criteria. Cash can be up to 10% and unlisted stocks up to 10%. The resulting portfolio will hold positions. Process: Portfolio Positioning Morningstar Holdings Based Style Map Deep Val Core Val Core Core Grw High Grw Giant Large Mid Small Micro World Regions Assets % Greater Europe 2.79 United Kingdom 2.67 Europe-Developed 0.00 Europe-Emerging 0.12 Africa/Middle East 0.00 Americas 0.22 North America 0.22 Latin America 0.00 Greater Asia Japan 0.00 Australasia 0.99 Asia-Developed 7.93 Asia-Emerging Not Classified 0.00 Sector weightings are a factor of stock fundamentals, with significant underweighting in financials and to lesser extents in basic materials, real estate, utilities, energy, and communication services. Conversely, the fund has overweightings to consumer cyclicals, industrials, consumer defensives, and Healthcare. The bias to smaller companies is evidenced by the allocation to mid-, small, and micro-caps, as defined by Morningstar, which is 54% compared with 1.8% for the MSCI China Asset Allocation Top 10 Holdings 28/02/2018 % Assets Long Short Net Cash Equity Bond Other % Assets Tencent Holdings Ltd 9.92 Alibaba Group Holding Ltd ADR 9.49 Fil Usd Loan 3.01% 02/14/ Tencent Holdings LtdCFD 6.57 China Pacific Insurance (Group) Co 4.07 Hutchison China Meditech Ltd 3.29 China Life Insurance Co Ltd H Share 2.58 Ctrip.com International Ltd ADR 1.98 Hang Seng Index Options Sept. 27, com Inc ADR repr Class A 1.91 Index and 11.7% for the China equity Morningstar Category. The fund provides exposure to the whole gamut of Chinese-oriented investments including China A-, B-, and H-shares as well as Hong-Kong-listed shares and US-listed companies. The portfolio is diverse, with around 140 names, seven short stock positions, and three short index positions. The top 10 names account for around 45% of total assets. Sector Weightings % Equity h Cyclical 42.3 r Basic Materials 1.0 t Consumer Cyclical 31.5 y Financial Services 7.1 u Real Estate 2.7 j Sensitive 36.3 i Communication Services 0.0 o Energy 1.0 p Industrials 12.3 a Technology 23.1 k Defensive 21.3 s Consumer Defensive 11.7 d Healthcare 8.1 f Utilities 1.5

4 Page 4 of 7 Morningstar Research Report Text as of 01/08/2017, Data as of 27/06/2018 NAV Performance Analysis Data as of Trailing Returns Price Total Rtn % +/- Bmark 3 month Month Year Year Ann Year Ann Over Nicholls' tenure here (April 14) to the end of July 2017, the fund has returned an annualised 26.5%, far outstripping the benchmark (MSCI China Index TR Index) return of 20.3%, the China Equity peer group of 18.7% and the MSCI China Small Cap Index of 10.6%. Calendar-year returns under Nicholls' management have been consistently strong; however, in calendar-year 2016, the fund, whilst outperforming peers, moderately underperformed the index. Over the past 12 months to June 2017, holdings in Alibaba, Tencent and Hutchison China Meditech's were accretive to performance whilst Sinosoft Technology, CT Environmental, and Green Dragon all detracted. Nicholls' record through the Fidelity Pacific fund is strong as is the attribution of the Chinese stocks within that fund. Trailing Returns NAV Total Rtn % +/- Bmark +/- Cat %Rnk In Cat 3 month Month Year Year Ann Year Ann Calendar Total Returns Fund(price) Fund(NAV) YTD 0 Discount / Premium Data as of Discount / Premium % 6 Mo 1Yr 3Yr High Average Low Z-Statistic Risk & Return Data as of Morningstar Rating Return Risk Rating 3 Year Above Avg High QQQQ 5 Year High High 10 Year Overall High High The board believes that it is in the best interests for shareholders that the price closely tracks the NAV. However, there is no formal target in this regard. This fund's long-term discount/premium rating has demonstrated substantial volatility. Subsequent to launch in April 2010, the fund tended to trade at a premium, which led the board to raise more capital in early 2011 through a C-share issue. Over the past five years, the average discount, however, is in the region of 9%, varying There are a number of risks about which investors should be aware. Nicholls isn't afraid to express strong views at sector, stock, and market-cap levels, including modest shorting and investment in unquoteds. The fund's standard deviation (a statistical measure of risk) is a little higher than peers or the index, but the fund's Sharpe ratio (or risk-adjusted return) has tended to be materially ahead of both, indicating that risk has been used to good effect here. The fund's beta (or between a modest premium to a high-teen discount. The board have been active in buying back shares into Treasury, and, since September 2011, they have repurchased million shares at a cost of GBP 114 million. There are some million shares currently outstanding and as at the end of March 2017 there were 19.4 million shares in Treasury. The current discount is 12% (August 2017). sensitivity to market movements) is modestly above one and greater than peers; however, despite this, its downside capture ratio has tended to be better than peers, suggesting that market protection measures have been effectively applied. Finally, at times, material use of gearing can add an additional layer of risk which investors should be aware of within the context of an already volatile market. Volatility Ratios 3 Yr NAV 5 Yr NAV Standard Deviation Mean Sharpe Ratio Sortino Ratio Risk vs Index 3 Year 5 Year Alpha NAV Beta NAV R-Squared NAV Treynor Ratio NAV

5 Page 5 of 7 Morningstar Research Report Text as of 01/08/2017, Data as of 27/06/2018 Fees Management Fee % 1.00 Ongoing Charge ex Perf Fee % 1.12 Fees incorporate an annual management fee and a performance fee arrangement. In March 2014, the management fee was reduced to 1% and the maximum permissible performance fee capped at 1% of net assets. The performance fee is levied at a rate of 15% on any NAV outperformance of more than 2% above the MSCI China Index. There are good features to this structure, such that outperformance cannot be carried forward, and that underperformance must still be made good before the performance fee kicks in which serves as a high water mark. We are supportive of the reductions that have taken place since inception, but in our opinion the combination of a regularly proportioned annual management fee and a performance fee makes for an unappealing combination that can lead to investors paying high level of fees. Ongoing charges excluding performance fees for fiscal-year 2017 were 1.16% (2016:1.2%), and there was no performance fee levied in For 2016 these accounted for GBP 9.1 million or the maximum capped level of 1% which meant that investors paid 2.2% overall (2015:1.79%). Gearing Total Assets Mil 1,939.5 Net Assets Mil 1,516.2 Dividends Dividend History YTD Dividend Special Dividend Total Nicholls uses two types of gearing in this fund. The first is a three year fixed-rate unsecured loan with Scotiabank for USD 150,000,000 arranged in February 2017 at a fixed rate of 3.01% per year. Nicholls can use short index positions for hedging purposes and also short stock positions on stock by stock specifics. The second form of gearing is the use of contracts for difference, whereby Nicholls will increase his weighting in certain stocks through CFDs rather than physically buying more Income is not a prominent feature of this fund as it is aiming to produce predominantly long-term capital growth. The board has, however, paid a modest dividend every year thus far. The initial distribution was 0.25p per share at the end of shares. Nicholls uses the two combined to manage gearing through cycles, but both the board and the manager believe in having gearing actively deployed. It is typical to see gearing in excess of 25%, but the formal range is 0 to 30% of total net assets. Currently, the fund's net gearing is 24% (August 2017) but Nicholls is quite active here and it was reduced to 13% through the summer 2015 market volatility. fiscal-year 2011, and successive years have seen this rise. For fiscal-year 2017, the fund paid a dividend of 2.5p per share (2016:2.07p) on earnings of 2.92p (2016:1.8p). The fund currently yields 1.15% (August 2017).

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We have identified five sources of economic moats: intangible assets, switching costs, network effect, cost advantage, and efficient scale. Companies with a narrow moat are those we believe are more likely than not to achieve normalized excess returns for at least the next 10 years. Wide-moat companies are those in which we have very high confidence that excess returns will remain for 10 years, with excess returns more likely than not to remain for at least 20 years. The longer a firm generates economic profits, the higher its intrinsic value. We believe low-quality, no-moat companies will see their normalized returns gravitate toward the firm s cost of capital more quickly than companies with moats. For more information about methodology in analysing stocks, please go to For Recipients in Australia: This Report has been issued and distributed in Australia by Morningstar Australasia Pty Ltd (ABN: ; ASFL: ). 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