Fidelity China Special Situations: July 2024 update

• Dale Nicholls is a veteran portfolio manager with over 27 years’ experience

• The trust fully utilises its ability to borrow and invest in private companies

• In March 2024, the trust merged with the abrdn China Investment Company

How it fits in a portfolio

Fidelity China Special Situations aims to grow capital over the long-term by investing in a diverse range of Chinese companies. The manager invests in companies of all sizes but tends to invest more in higher-risk smaller companies than the benchmark. This also includes private companies which aren't currently listed on a stock exchange.

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. This makes the trust a more adventurous option and should only form a small part of a diversified portfolio.

Manager

The trust has been managed by veteran investor, Dale Nicholls since April 2014. Nicholls is a Fidelity ‘lifer’ having joined the company in 1996 and has spent most of his time focused on Asia. 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.

The manager has the support of a wide range of research resources at Fidelity, including 35 analysts based in the region. Nicholls draws on the research and insights from these analysts, including regular support and challenge. The team also has great access to company management to enhance their research.

In March 2024, Fidelity China Special Situations merged with the abrdn China Investment Company which saw the trust acquire around £127m in assets.

Process

Nicholls’ strategy focuses on identifying companies that the market undervalues and investing in them for the long term. The emphasis is on well-managed companies with strong growth potential. Nicholls dedicates a significant amount of time meeting with companies and their competitors to understand a thorough understanding of the industry dynamics.

He leverages Fidelity’s extensive team of analysts to generate investment ideas for the trust. Their bottom-up research involves detailed analysis to understand their financial health and what they are worth. Nicholls utilizes their research to piece together the portfolio, carefully considering the risk and reward offered by each company. Typically, he will initially only invest a small amount and build positions gradually as his understanding and confidence in the company grows.

This results in a portfolio that diverges significantly from the benchmark. For instance, the manager invests more in smaller, higher-risk companies. Companies of this size are often less researched, providing Nicholls and his team with opportunities to invest before their potential is realised by the wider market. Although the trust currently invests less in larger companies, it still holds substantial positions in leading Chinese firms such as Tencent, Ping An Insurance and Alibaba Group.

China is the second largest economy globally and Nicholls believes the growth of China's middle class and an increasing focus towards domestic consumption will be key drivers of growth in the coming years. Sector wise, the manager invests much more in consumer-focused companies, he also finds plenty of opportunities in healthcare and industrials.

Closed-ended investments like this investment trust offer managers greater flexibility than open-ended funds. For instance, the trust makes full use of gearing (borrowing to invest to try to boost returns). At the end of March 2024, net gearing stood at 20.8%.

The trust 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). This increases risk as these companies are less liquid (more difficult to buy and sell) than listed ones. At the end of the trust’s latest financial year (March 2024) 12.8% of the trust was invested across five unlisted companies. During the year, three of their unlisted companies listed on the public market – known as an IPO – these were Beisen, Cutia Therapeutics and Tuhu Car.

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 and investment trusts. We think this aligns their interests with those of investors.

ESG integration

Fidelity has committed to improving its approach to ESG (Environmental, Social and Governance issues) in recent years. The firm developed a structured engagement program which allows them to be more systematic in their engagement on environmental and social issues, become involved in more collaborative engagement initiatives and introduced ESG data into fund managers’ quarterly reviews to raise awareness of ESG issues. The firm also bolstered its dedicated ESG team, which writes regular ESG reports on companies held by Fidelity fund managers. The firm votes where it is possible to do so and quarterly voting reports are posted online, complete with rationales for votes against management and abstentions.

In June 2019, Fidelity launched its own proprietary ESG ratings tool. It scores thousands of companies based on their ESG credentials on a forward-looking basis, with investment analysts tasked with the job of ensuring the ratings are up to date. The ratings system has recently evolved to include an assessment of each company’s ability to manage negative externalities. Fidelity is also rolling out a climate rating which identifies companies they should engage with most as part of their aim to halve portfolio emissions by 2030 and reach net zero by 2050. While Fidelity has made strides forward at the firm level, we don’t think this has fully fed through to the fund level. While there is plenty of ESG information available to all Fidelity fund managers, we’re not yet convinced they all put it to full use.

Cost

The ongoing annual charge over the trust’s financial year to 31 March 2024 was 1.13%, which includes the trust’s variable management fee. Investors should refer to the latest annual report and accounts, and Key Investor Information for details of the risks and charging structure.

If held in a SIPP or ISA the HL account charge of 0.45% (capped at £200 p.a. for a SIPP and £45 for an ISA) per annum also applies. Our account charge doesn't apply if held in a Fund and Share Account or a Junior ISA. As investment trusts trade like shares, both a buy and sell instruction will be subject to our share dealing charges within any HL account except online deals in a Junior ISA.

Performance

Since Nicholls took over management of the trust in April 2014, he’s delivered strong returns to investors and comfortably outperformed his benchmark. Over this period the trust’s net asset value rose by 123.96%* versus 58.03% for the MSCI China Index. The share price also grew by 134.88%. Past performance is not a guide to the future. Remember, investments can go down as well as up in value and you could get back less than you invest.

Single country focused investments carry increased risks and given the trust's focus on smaller businesses and use of gearing performance can be volatile, and returns are likely to look different from the market at times.

In the 12 months to the end of March 2024, the trust fell 16.45% in share price terms, and 16.48% in net asset value terms. The benchmark declined 18.81% over the same period.

Consumer focused companies were some of the top performers over this period such as Hisense Home Appliances Group. The company’s share price rose significantly as investors realised the potential in its low valuation and growing market share. Other notable performers included e-commerce platform PDD Holdings and BC Technology Group.Ca

Detractors included holdings such as Hesai Group and Intron Technology Holdings. These companies feed into different stages of automobile production, a market which has come under pressure from competition and pricing pressures.

Whilst the primary focus of the trust is on capital growth, it has grown the dividend every year since launch in 2010. The board has proposed a total dividend for the year to the end of March 2024 of 6.40p per share. This is a 2.4% increase on the previous year. At the time of writing the trust has a dividend yield of 3.30% (not a reliable indicator of future income). Please remember that dividends are variable and not guaranteed.

Please note the share price of investment trusts can trade at a premium or discount to their net asset value (NAV). At the time of writing the trust trades at a discount of 8.98%. This compares to an average discount of 9.86% over the last 12 months.