Rather than moaning about discounts on alternative asset funds again, how about a good news story from an equity-focused trust?

This past week saw the publication of annual results from Fidelity Asian Values (FAS ). The numbers were good – a NAV total return of 11.4% for the 12 months ending 31 July, which was 3.9 percentage points more than the benchmark, the MSCI All Countries Asia ex Japan Small Cap index. A narrower discount meant shareholders got a return of 17.3%.

All of this was produced against a backdrop of pretty poor economic and market performance from the regional powerhouse of China.

Those good returns extend a good long-term record. Over the past 10 years, FAS is the second best performing of all Asia-focused trusts in both NAV and share price terms, behind Pacific Horizon (PHI ). The Fidelity trust has generated average returns of more than 10% per annum over this period and since its launch in June 1996 it has beaten its benchmark by more than 200 percentage points.

Nitin Bajaj, a stock picker with a bias to value and one eye on protecting the downside risk in the portfolio, has managed the fund since April 2015. 

I find it interesting that a value approach has produced long term returns that are almost as good as the growth focused style followed by PHI. Albeit there has been significant divergence in their performance during certain periods of Bajaj’s tenure.

FAS had a bit of a shocker in the accounting that ended in July 2020. Value and smaller companies were very much out of favour as investors fretted about the impact of COVID and Bajaj avoided the technology sector which was driving markets as he felt many of the companies were overvalued.

However, since the lows of March 2020 FAS’s shares have doubled helped by the switch in sentiment towards value due to higher inflation.

I mentioned how disappointing China has been this year. There was a firm belief by many investors (including me) that when China reopened its economy following the COVID lockdowns, there would be a sharp and sustained recovery. Share prices rose but Chinese consumers sat on their hands, global demand has been weak, consumer prices fell leading to deflation and problems resurfaced in the construction industry.

Bajaj did take profits as Chinese stocks rallied in the immediate aftermath of the end of lockdowns. However, as most investors have become more pessimistic about the outlook, the manager adopted a contrarian view, building exposure to the country, taking advantage of lower valuations. He has said the current economic weakness is transitory and companies that can navigate the downturn will emerge stronger as they pick up market share from weaker players.

The result is a portfolio that has a significant overweight exposure to China at 28.5%, compared to the benchmark index’s 8.9% at the end of August 2023. It would be easy to get hung up on the risk implications of this but the shape of FAS’s portfolio is driven by Nitin’s stock picking. There is a quality aspect to Bajaj’s investment approach. To be considered for the portfolio, a company should have a defensible business policy that allows it to earn high returns on capital, and good management that can be trusted to act in shareholders’ best interests.

It is also worth bearing in mind the contrast between the geographic dispersion of the MSCI AC Asia ex Japan index and its small cap counterpart. In the large cap index, China is over 34% of the pie because of the different rules that govern the indices’ construction.

FAS has an underweight exposure to India as the manager is wary of high valuations. The country has been one of the strongest markets in the region for a while now, with Indian small cap specialist India Capital Growth (IGC ) producing some of the best share price returns of all equity-focused funds over the past 12 months.

While the manager’s geographic asset allocation made a negative contribution to returns during the financial year stock selection more than compensated for this.

A differentiating factor for FAS is its ability to short stocks, which is the responsibility of the assistant manager Ajinkya Dhavale. Individual short positions are not especially large, the largest was 0.4% at the end of August 2023, and the board has imposed a limit of 10% on the total short exposure. These have been making a modest positive contribution to FAS’s returns in recent years.

In Asia, small cap stocks sit at a valuation discount to large caps and FAS’ investment approach mean that its portfolio is cheaper still, which should help limit the downside if markets retreat. However, Bajaj acknowledges that short-term market moves are impossible to call. His focus remains on identifying the best opportunities from an enormous universe of around 19,000 companies. This is one I would back for the long term.

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