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Fidelity China Special Sits on a 15% discount: Is it a buying opportunity?

19 August 2015

The well-known trust is still seen negatively by some despite its strong performance compared to the MSCI China benchmark and has fallen from double-digit premium to double-digit discount, dragging total return down.

By Daniel Lanyon,

Senior Reporter, FE Trustnet

The much vaunted Fidelity China Special Situations investment trust has moved to its highest ever discount in the past month following a huge plunge in sentiment to Chinese equities and a subsequent dive in the country’s stock markets.

Investors have been panicked out of the market due to concerns that China is heading for a prolonged crisis with lower economic growth not helped by feeble export data, leading the country’s central bank to dramatically weaken the value of the renimbi last week.

The £1.1bn Fidelity China Special Situations trust is currently on a 15 per cent discount. Although it went down as far as 23 per cent back in July investors were quick to pile in and the discount narrowed back sharply to reach its current level.

Data from the London Stock Exchange shows a huge uptick in trading around the time of the discount, suggesting when investors dumped stocks they were quickly hoovered up.

But disregarding those managing China funds and trusts, there have been few sanguine voices for the short-term outlook of Chinese equities of late.

Nonetheless, analysts such as Cantor Fitzgerald’s Charles Tan (pictured) say Fidelity China Special Situations is one of the best vehicles for investors to re-enter the Chinese market owing to its double-digit discount and the skill of manager Dale Nicholls. However, he adds they should be prepared for the potential for more short-term pain.

“The huge discount spike was a signal that this is an attractive fund and people do believe in the strategy, they do believe in Fidelity as the preferred management for investing in that part of the world and they see the merits of a closed-ended fund,” he said.

“Whether it is a good buying opportunity really is a macro view that you have to take. Personally, I feel there is a bit more pain to come before things get better."

“The currency devaluation was the best thing the [Chinese] government could do ... but they could have to do more. It feels like we are not quite done yet in terms of the pain trade. That said China is still a massive opportunity.”

Being one of the most anticipated investment trust launches in history, Fidelity China Special Situations was heavily oversubscribed when it listed in April 2010, meaning it moved to a premium of 14 per cent within months. Since then it has a falling premium move to an ever widening discount with little interruption, as shown in the chart below.

Discount history since over 5yrs

 

Source: FE Analytics


The trust seems to have found a floor at its current level, according Tan, who adds the long-term case for investing in China is sound despite the potential for further negative sentiment in the short run.

The trust has been managed by Nicholls since April 2014, following the retirement of the well-known Anthony Bolton who launched the trust back in 2010.

It has returned 31.65 per cent since launch from the a total return point of view, meaning it has beaten its MSCI China benchmark index by more than doubling its 15.79 per cent gain over the same period.


Performance of fund and index since launch

 

Source: FE Analytics


However, the trust’s growth in its underlying portfolio – or net asset value [NAV] – has been 60.87 per cent over the same period, showing the impact of the discount on total return.


Performance of trust’s NAV since launch

 

Source: FE Analytics


Since Nicholls took over the Fidelity China Special Situations investment trust in April 2014, the closed-ended fund has rocketed up, partly thanks to an initial bull run in Chinese stocks that preceded the current nose-dive. However it stayed ahead of the index during this down market period.

This was due to Nicholls’ stock-picking and ability to short the index, Tan says.

“I very much like the trust and very much like Dale Nicholls and what he is doing with the trust. It is one of the only China vehicles out there where you have a truly active manager,” he said.

“The fact it hasn’t declined as much as the index [in the sell-off] would indicate that there is some alpha being added from stock picking.”

Nichols recently told FE Trustnet that he is not perturbed by the falls and has been buying into the correction.


“Investors have clearly been spooked by the correction in the markets, but I think this is overdone and is creating good buying opportunities. The fundamental case for China remains intact: growth remains strong in a global context, especially in the area of consumption, which is supported by long-term trends such as urbanisation,” he said.

“The path for reform is set and this will continue to create opportunities, especially for innovative private companies. Stock picking will be key. Recent events have shown that the rapid growth in margin-led investing clearly got ahead of itself in the sharp market run and we are now feeling the effects as this is unwound.”

“This will likely take some time and markets will remain volatile. Policy response on the whole has been disappointing and in many ways runs contrary to the spirit of broader reforms and general market liberalisation.”

Innes Urquhart, analyst at Winterflood Securities, says the trust is risky but is looking progressively more attractive.

“Fidelity China Special Situations has developed a strong, albeit volatile, performance record over the last five years, helped by gearing and its significant small‐cap bias,” he said.

“We believe that these factors increase the fund's risk profile over and above that typically associated with a single‐country emerging markets fund. Despite a significant recent increase in buyback activity, the fund's discount has continued to widen during a period of high volatility.”

“In our opinion, while the Chinese stock market is likely to remain volatile in the short term for the reasons highlighted above, we believe Fidelity China Special Situations offers an increasingly interesting, if high risk, value play for contrarian orientated investors. In addition, we see the recent recruitment of a dedicated Chinese small-cap analyst as a positive development.”

Fidelity China Special Situations has an ongoing charges figure of 1. 36 per cent and a performance fee which most recently totalled up to 2.01 per cent. Gearing is 22 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.