Stellar year for Fidelity China Special Situations as it enjoys highest annual NAV return – Fidelity China Special Situations (FCSS) has recorded its highest annual net asset value total return of 81.9% and share price total return of 97.2%, as revealed in its annual financial report for the year ended 31 March 2021. This was significantly ahead of the MSCI China Index return of 29.1%. The board recommends an annual dividend of 4.68 pence per share, an increase of 10.1% from last year.
The company’s discount narrowed significantly from 8.6% at the start of the reporting year to 1.1% by its end. During the period, the board authorised the buyback of 23,345,560 shares into Treasury, representing 4.1% of issued share capital. These share repurchases have benefited remaining shareholders as the NAV per share has been increased by purchasing shares at a discount.
The stellar performance can be largely attributed to ‘excellent opportunities’ found in the unlisted space in China, which has expanded quite markedly. At the reporting year end, the trust had 7.4% of net assets plus borrowings in nine unlisted holdings. Subject to shareholder approval, the board proposes increasing the company’s permitted limit in unlisted holdings from 10% to 15% of net assets plus borrowings.
Chairman, Nicholas Bull, said: “Over the years we have been able to make investments in unlisted companies who have established their business model and are looking towards an IPO. Fidelity International has grown its expertise in this area both in identifying and also in valuing new opportunities and then in monitoring them as they progress to their IPO. At the same time the period from investment to IPO has lengthened as unlisted companies are finding it possible to fulfil their capital needs with more rounds of capital raising pre-IPO. Taken together this has led us to conclude that we should have the ability to hold a greater proportion of the Company in unlisted investments. We are therefore placing before shareholders, at the Annual General Meeting, a proposal to increase our limit from 10% to 15% of Net Assets plus Borrowings.”
[The move into unlisted companies has been a good one for Fidelity China Special Situations over the past decade, starting with its first unquoted investment in Alibaba in 2012 by then manager, Anthony Bolton. He placed 2.5% of the trust’s assets in the company, then valued at $48 billion, which went on to see the biggest IPO offering in history in 2014. Manager Dale Nicholls has only continued this with a clear eye for knowing where the opportunities for similar success lie. While of course there lies increased risk with investing in private companies, FCSS’s track record in the space proves the team knows what it is doing and so increasing its limit makes sense in order to capture further value.]
Statement from the manager:
“The year under review has certainly been one of the most challenging and unusual times I have experienced as an investor. The economic and social impact from COVID-19 has been unprecedented – at least in modern times – which in turn, has seen us work and live in different ways.
With borders generally remaining closed, not just in China but across the Asia Pacific region and around the world, virtual communication has become the new ‘norm’. From an investment perspective, our research process has remained robust, with Fidelity’s investment team swiftly adapting to the changes we have endured. We have been doing a similar number of meetings, but mostly in a virtual format – and have found company management teams on the whole being very amenable and adaptable to this new reality. I still very much value face-to-face contact with management teams and on the ground due diligence meetings with the companies we invest in. The good news is that with life very much back to normal on the ground in China, our team there is back to doing just that. Without a doubt, our research team’s ongoing dedication and focus during this review period has been a key contributor to the portfolio’s strong performance.
From an attribution perspective, ‘New China’ and consumer related stocks were particularly strong performers over the year. Of the 81.9% NAV total return, 47.1% was due to stock selection and 11.1% was from gearing. The strength of sterling detracted 18.3% from returns over the year. Further details on all the components contributing to the NAV total return are in the Attribution Analysis in the Annual Report. Many shareholders will remember that I previously showcased China Meidong Auto Holdings. Over the year, it has benefited from improving margins in car sales, coupled with strong after-sales services growth. It is also worth noting that during the peak of the lockdown in China back in the first quarter of 2020, we spoke to its management team who expected that strong brand and customer relationships would help position them well for when the pent-up demand story played out. Given China Meidong’s significant share price appreciation, I have reduced our exposure, but it still remains a core position in the portfolio.
Also, within the transportation industry, a position in China’s largest two-wheeler e-bike manufacturer, Yadea Group Holdings, has been a notable contributor to performance. Yadea’s strong brand, coupled with its expanding distribution network and focus on innovative and differentiated products underpinned the share price’s performance. However, with valuations here also becoming less attractive, I have closed out the position.
Focusing now on the healthcare segment, Wuxi AppTec (another core holding that I have previously highlighted) benefited from ongoing strong global demand for contract research and manufacturing services. The company’s ability to grow its strong talent pool is a key strength. Looking ahead there is exciting potential upside from new technology developments, such as its cell/gene therapy business.
In terms of consumer technology companies, participating in the Hong Kong Initial Public Offering (IPO) of the Chinese short-video application company Kuaishou Technology also added to performance. Regarded as one of the most popular social platforms in China (akin to ByteDance, which is an unlisted position in the portfolio), Kuaishou’s better-than-anticipated quarterly earnings lifted sentiment towards the stock. While the IPO was deemed to be a great success, the company’s growth outlook remains promising as it’s supported by the ramp-up of monetisation in advertising and livestreaming e-commerce.
The exposure to leading carrier-neutral internet data centre services provider 21Vianet Group also proved rewarding, with strong performance supported by robust demand for its cloud services, coupled with expectations of increased demand for fifth generation (5G) applications. In our view, its management has delivered on its strategy as it continues to expand the base of large wholesale clients.
Conversely, not holding the likes of Meituan, Nio and Baidu weighed on relative performance as these stocks performed strongly over the reporting period. While I remain very positive on the outlook for industries such as electric vehicles, in many cases I find very little margin of safety given current valuations.
In the “less-loved” parts of the market such as the materials sector, investments relating to the ‘industry consolidation’ theme delivered solid returns. Many industries remain very fragmented compared to industry structures we see in the West, but the process of market consolidation is clearly underway and it may have accelerated with the disruption the pandemic has brought. We remain very focused on identifying the winners to come out of this process.
One of the subsectors that I have found attractive is the paint business, which is characterised by high margins, robust returns on capital and strong cash flows. Furthermore, and as highlighted above, industry dynamics coupled with increasing demand have resulted in leading paint players gaining market share, for example SKSHU Paint Company, one of China’s largest paint manufacturers. It offers products such as exterior architectural coatings, interior household paint products and waterproofing materials. Consistent market share gains have driven strong top-line growth and disciplined cost control has helped it maintain healthy margins. In the type of macro environment we have endured over the year, it’s been paramount for me and our analysts to focus on how management teams manage their costs and cash flows. The Company also holds Asia Cuanon Technology, another leading paint producer. It is also well positioned to benefit from industry consolidation, urban renovation and its penetration into lower tiered markets. Suffice to say that these factors have helped Asia Cuanon perform strongly over the year.”
FCSS : Stellar year for Fidelity China Special Situations as it enjoys highest annual NAV return