FCSS share price reverts to launch cost

Fidelity China Special Situations' net asset value has increased by 19.5% on a total return basis in the year ended 31 March, compared with its MSCI China Benchmark Index which fell by 6.9% over the same period.

However, it says its share price has reverted close to its launch price because investors have recently steered clear of emerging markets.

Performance was boosted by stock selection and the use of gearing and contracts for difference to magnify performance.

The trust is invested in several healthcare companies such as Lee's Pharmaceutical and Hutchison China MediTech, which rose sharply as investors started to put higher valuations on their new drug pipelines.

Internet companies

It has also benefited from internet companies which have performed well including Alibaba, which is set for the largest ever IPO for a Chinese company in the US.

The trust's shares produced a total return of 14.1% over the year, due to a 0.15p increase in dividend and 13% rise in the share price. However, the shares have dropped back recently and remain close to the trust's 100p launch price. As Friday progressed, they rose to 101.10p, up 0.3% on the day.

Anthony Bolton is handing over the reins to Dale Nicholls, who has been at Fidelity for 18 years and managed money in Asia since 1999.

The Chinese government is looking to move away from an economic model driven by state-directed investment spending, towards a market-based economy focused on the country's consumers, as witnessed by the Third Plenary reforms in November.

Nicholls says he likes names related to rising Chinese wealth and underpenetrated areas of consumption, and that the fund holds SAIC Motor, which manufactures Volkswagen and GM automobiles via a joint venture, and Gree Electrical Appliances, which sells high-quality air conditioning units.

A number of holdings in the portfolio also fall within the theme of increased travel such as China Lodging and China International Travel. The main destination for Chinese tourists is Hong Kong, often for shopping expeditions, and the company owns a number of high street retailers set to benefit from this trend, such as cosmetics retailer Bonjour and jeweller Luk Fook.

Nicholls also says that macro-economic concerns about China have created investment opportunities for bottom-up stock pickers and that although "New China" is where he primarily wants to invest, there are opportunities in unloved state-owned enterprises which have high barriers to entry and can benefit from reforms.

The new portfolio manager gave the example of Guangshen Railway, which has not been allowed to raise passenger prices since the mid-1990s. He also mentions that, similar to Bolton, he has a small and mid-cap bias as these tend to be less researched, creating greater opportunities for mis-pricing.

High GDP growth

Meanwhile, Bolton says that concerns about the sustainability of high GDP growth in China, and the country's high debt, are frequently evaluated from a Western perspective. "It is true that the overall level of debt in China is high although, unlike in some countries in the West, the greater part of the borrowings is corporate rather than government or personal debt," he says.

"Partly this is due to corporates having to rely on debt because they are unable to source funds from capital markets as they would in the West. Although debt levels are high, so is the savings rate (much higher than in the West). A high savings rate makes higher debt levels less concerning. Also, nearly all the debt is borrowed internally so it is not exposed to changes in foreign lenders' views about China."

He added that his biggest mistake over the last four years has been his optimism about the overall Chinese stockmarket. However, he says "at the time of writing, stockmarket valuations in China are very cheap relative to their historical levels on most measures, sentiment is very negative and the local 'A' share market has been in a bear market for over four years".

He adds: "These factors all suggest that now should be a time to be positive about the market outlook as much of the bad news is already discounted in prices. Hong Kong-listed medium and smaller-sized companies still appear very cheaply-valued against their mainland-listed peers. I expect this valuation gap to close in the future as more mainland money is allowed to invest in Hong Kong.

"Of course, China is not without risks and I have mentioned the longer-term challenges on the political and social front often in my previous reports. I believe there has to be more reform on this level over the next decade. Also the Japan-China relationship and events in North Korea must be watched as they could destabilise developments in the shorter term."