Outperformance but still deeply negative year for Fidelity China Special Situations

The Fidelity China Special Situations (FCSS) announced its annual report for the period ended 31 March 2024. During the year, the company reported a NAV total return of -16.3% and an ordinary share price total return of -16.4%. This was ahead of the benchmark Index, the MSCI China Index, which returned a total return of -18.8% (in UK sterling terms) over the same period. Despite the recent struggles, the company’s long term performance remains impressive with the NAV outperforming the benchmark Index over one, five and 10 years. Over the last 10 years, it has generated a total shareholder return of 125.7% (NAV total return of 123.0%), some 75% ahead of the benchmark Index return of 49.3%.

A notable event during the year was the transaction with the abrdn China Investment Company Limited. This was concluded on 14 March 2024 and is expected to provide benefits to both existing shareholders of Fidelity China Special Situations and former holders of ACIC.

Commenting on the performance, chairman Mike Belfour noted:

“The main driving force of the Chinese economy in the past 10 years has been investment – whether at the government, business or household level – leading to improvements in infrastructure, strong export growth and a property boom. In the current environment, export growth has weakened as a result of global supply chain diversification away from China as well as US trade reluctance (expressed via tariffs and sanctions), and infrastructure is now developed to the point where the marginal impact of additional investment is reduced. Concerns in the property market – particularly in the new-build sector, which has a stronger contribution to overall growth – have been well documented in recent years. With these three stalwarts of economic growth curtailed a 5% GDP growth target – would be a good outcome that underscores China’s resilience. While a US plan to further restrict sales of advanced semiconductors to China adds an element of uncertainty, particularly in some areas of technology and automation, it is leading to a wave of Chinese invention and investment to compensate. So far, China has surprised in its ability to keep innovating in microchips in particular. It is also leading the world in electric vehicles, green energy technologies and battery technology and is making strong progress with AI. All these are becoming increasingly important industries that China could seek to lead globally in the future.

“Meanwhile, the Chinese stock market remains one of the most lowly-valued large, liquid markets in the world. Market-level performance has been disappointing for three years now, and it is always difficult to know when share prices will start to reflect intrinsic value rather than being marked down on poor sentiment. However, the companies in the portfolio continue to show strong earnings growth, and we remain confident that the market will come to appreciate the value on offer in the future; it may already have started to happen. As ever, having a large research team on the ground in China is fundamental to success in seeking out the best opportunities, particularly among smaller and medium-sized companies, where the relatively higher growth potential has yet to be reflected in share prices, and investor awareness is low.”

Regarding the outlook, he continued:

“While the Chinese economy remains sluggish, having failed to reap fully the benefits from the post-COVID reopening, there are undoubtedly signs of improvement. The March PMI figure – a measure of the economic health of the manufacturing sector – moved into positive territory (a reading above 50) for the first time in six months, reaching its highest level since March 2023 and potentially signalling a more sustained period of improvement. April trade data was good and showed a rise in imports, indicating a possible rise in domestic demand. At the same time, it is heartening to see that the Chinese authorities have not been panicked into implementing one-off large measures to boost the economy. They are going about things in a gradually stimulating fashion on both the fiscal and the monetary side, which will hopefully lead to a more balanced outcome. Meanwhile, with Chinese equity market valuations at particularly low levels, both relative to their own history and in a global context, there should be many opportunities for investors to participate profitably in the recovery.

“Perhaps the major risk to our cautiously positive outlook is the forthcoming US Presidential election. US relations with China have stabilised somewhat, although increasing tariffs and trade restrictions remain a concern. There is a significant risk that relations could worsen and US may implement measures such as raising tariffs on imports from China to 60%, which would significantly harm Chinese exporters and would depress global trade and exacerbate US inflation trends.

“In Chinese culture, the Year of the Dragon is associated with great change, good fortune and prosperity, to such an extent that Dragon years have historically experienced ‘baby booms’. While there can be no certainty that the Chinese equity market is itself on the verge of a boom, the structural trends at play in the economy, coupled with Dale and his team’s focus on selecting the stocks best positioned to deliver value to shareholders, should continue to support our positive medium to long-term view.”

FCSS : Outperformance but still deeply negative year for Fidelity China Special Situations