Fidelity China Special Situations, managed by Dale Nicholls (pictured), has announced its results for the half-year ended 30 September 2015. During the period, the company’s NAV fell by 14.1% and the share price by 16.2%, both beating the performance of the Benchmark MSCI China Index, which fell 19.7%. The company’s outperformance was primarily due to strong stock selection however the manager’s decision to reduce the Company’s net gearing in the second quarter of the year, reflecting concerns that there were signs of over-optimism and pockets of stretched valuations, has also supported relative performance.
This has been a volatile period for China but the manager believes that the slowing GDP rate is a natural process for China’s economy as it transitions from a government-spending and investment-led model to a consumer-driven model. He comments that the final GDP growth number hides great variations between different sectors of the economy and that, while we continue to see declines in areas of heavy industrials, sectors such as services have maintained close to double-digit growth and continue to grow in importance. The manager says that the majority of the portfolio’s investments are focused in these areas as he believes they offer long-term structural opportunities. The manager believes that August’s correction was essentially a technical issue and did not fundamentally change the general market outlook. He says that there was talk that the decline in the market could create a negative wealth effect and lead to a slowdown in consumption. However, the general public has relatively low exposure to the stock market and there was little evidence of a consumption boost when markets were on the rise.
In May, the manager trimmed some strong performing long positions, such as China Lodging and SAIC Motor reflecting his concerns about the sharp rally in Chinese equities and that valuations were generally looking stretched. A few short positions were added in stocks whose valuations were at extreme levels. In addition, the manager opened a significant short position on the A-Share index given what he saw as the risk of a correction. These short positions supported performance when the market declined. However, the manager says that towards the end of the reporting period, valuations were priced on an overly negative scenario and many indicators suggested that the market was oversold. Consequently, many of the short holdings have since been unwound and long positions once again added.
With regard to specific stocks, a holding in VIPShop was made, a new position in Dongfeng Motor was purchased and a new unlisted position of US$15.5m in Didi Kuaizhi was made in the portfolio.
With regards to the performance of specific portfolio companies, US-listed Chinese companies China Lodging and NetEase supported returns. China Lodging, a low budget hotel chain, rallied after it recorded an improvement in profits. NetEase, a leading information technology company with online games and email services, saw strong revenue growth following an acceleration in online gaming growth and strong growth in ecommerce. Café and bakery chain Gourmet Master rallied due to a turnaround in its profit margins on the back of strong cost controls, a pick-up in same store sales growth and higher margins at its US business. The position in China Hutchison Meditech also added value as its oncology drugs which continue to record strong clinical trial data, are getting closer to receiving regulatory approval.
Conversely, positions in the financial sector hurt returns. CITIC Securities was significantly impacted by the tightening and unwinding of margin finance, although the position was substantially reduced during the period. Insurance companies China Pacific Insurance and Ping An Insurance also detracted from returns despite posting good results. Investors took profits in these stocks following a strong run.
Looking forward, the manager would like to see more focus by the government on the execution of the long-term reform agenda, including state-owned enterprise reform although he says that there are many interesting long-term investment opportunities, in his view, that nare underpinned by secular changes and reform in China. Many have have seen their share prices impacted by short-term concerns but, in his view, such circumstances mean valuations are compelling for investors.
Fidelity China Special Sits benefits from strong stock selection and timely gearing reduction : FCSS