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Canaccord: ‘buy’ Fidelity China after another excellent year

13 June 2018

Canaccord Genuity analyst Alan Brierley abandons long-standing caution on Fidelity China Special Situations, upgrading highly geared trust to ‘buy’ from ‘hold’ after another impressive year of performance.

Canaccord Genuity’s Alan Brierley has abandoned his long-standing caution on Fidelity China Special Situations (FCSS), upgrading his recommendation to ‘buy’ from ‘hold’ after another impressive year of performance for the highly geared, single country investment trust.

For the 12 months to 31 March, fund manager Dale Nicholls generated a 22.2% total return on net assets, with shareholders receiving a total return, including last year’s dividend, of 23.6% as the shares narrowed the gap – or discount – between their price and underlying net asset value (NAV). The latest dividend it has declared is 40% up on last year at 3.5p per share.

Although the total return was slightly less than the 23.8% achieved by the MSCI China index, the underperformance was explained by the trust not holding as much as the benchmark in soar-away tech giants Tencent and Alibaba.

On a longer-term view, the year’s advance extends the trust’s outperformance both under Nicholls and since the trust’s launch eight years ago under former star manager Anthony Bolton.

Since Nicholls replaced Bolton in April 2014, NAV per share has grown 146.6%, slightly ahead of the total shareholder return of 140.6%, according to the company, with the MSCI China trailing on 98.9%.

From its launch in April 2010 its NAV has nearly trebled with a total return of 192.6%, although shareholders have had to settle with 155.8% because of the discount on the shares. That’s not a big problem given the index has returned just 87.6%.

With the shares continuing to trade nearly 13% below NAV over ongoing nervousness over emerging markets and China’s strained relations with the US, Brierley has decided there is no point in postponing a more positive view of the stock, having rated it ‘hold’ for five years.

‘Given exceptional gains, our recommendation has been to wait for a more attractive buying opportunity. However, we acknowledge this has been too cautious (ie, wrong) and also highlights the risks of tactical calls. We upgrade to “buy”,' the investment companies analyst told investors today.

Warming to his theme he described FCSS as: ‘A well-diversified portfolio consists of companies with strong growth potential that give investors exposure to China’s New Economy and the spending power of China’s middle class.

‘A classic stock-picking portfolio will typically bear no resemblance to the benchmark; notably there is a significant tilt towards mid and small-caps, with the exposure currently 55.1% vs. 13.4% for the MSCI China index,’ he added.

Charges cut

More good news for investors is a cut in the trust’s charges. FCSS is adopting the variable management fee that other funds and trusts managed by Fidelity have implemented in the past eight months. This will see its fixed 1% annual management charge and additional performance fee of up to 1% replaced by a new headline charge of 0.9% that can vary by 0.2% depending on its NAV returns against the benchmark.

This means a charge of between 0.7% and 1.1% compared to the 1.16% they had paid in previous years.

Healthcare and financials

In his commentary on the results published yesterday, Nicholls admitted his focus on smaller and medium-sized companies had also detracted from the returns compared to the index, but added that ‘with the valuation gap now relatively wide in a historic context, I feel positive about the potential for small-caps to start closing the performance gap’.

‘Ways of getting exposure to this [consumer] theme remain varied and include direct consumption, consumption via the internet, as well as areas of future consumer focus, like healthcare and services,’ said Nicholls.

‘I have been looking at private health as I see significant government appetite for shifting financial burden of the healthcare system away from the state,’ he said. ‘I have been increasing my allocation to China Resources Phoenix Healthcare.’

In a similar vein, the trust has also increased its weighting to financials, mostly through to upping life insurance exposure through China Life Insurance and China Pacific Insurance, to benefit from wealthy Chinese saving more and taking out insurance.

‘China is at a very early stage in life insurance and this market offers significant growth potential,’ he said. ‘The insurance sector has lagged the market due to policies limiting growth in more savings-type products. This has created buying opportunities and the shift to more protection-type products will ultimately create more value for the companies.’

Trump threat

Nicholls said the portfolio’s domestic focus meant it was not directly affected by president Trump’s tariffs on Chinese imports, although if a trade war hurt global trade that would be a problem.

‘I take the view that this scenario is unlikely given the obvious drawbacks for all players,’ he said.

‘One concern for me is how China might react to the US and whether it too might increase tariffs,’ he said. ‘Ultimately this could push up input costs for Chinese companies, which will be passed on to consumer or eat into profits, neither of which is a good outcome for investors.’

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