The “best ideas” playing out in the Fidelity China Special Sits trust
01 September 2014
Analysts on Dale Nicholls’ Fidelity China Special Situations investment trust have examined four themes that they expect to drive Chinese equity investing over the years ahead.
Chinese equities have outperformed developed market stocks over 2014 so far, with the MSCI China index rising 7.60 per cent while the MSCI World gained 6.51 per cent, after investors’ concerns about the health of the world’s second largest economy started to moderate.
Both have been behind by emerging market equities, however, which have seen a strong rally recently after going through a tough 2013. The MSCI Emerging Markets index is up 10.53 per cent over the year to date, following the fall of 4.41 per cent seen in the previous year.
Performance of indices during 2014 to date
Source: FE Analytics
China is attempting to reform its economy to move away from its investment-heavy, export-oriented model towards a model where consumption is the main driver of growth.
The Chinese authorities believe this is the best way to tackle some of the main triggers of social unrest while investors such as Nicholls think the move towards a ‘new China’ could throw up interesting opportunities.
One area where Nicholls doesn’t see much investment potential is the Chinese banking sector, which has been blighted by raft of issues.
Fidelity China Special Situations has 24.3 per cent in financials, underweight the 37.2 per cent in the MSCI China index, with very little in banks.
Nicholls says “now is not the time to be invested in the banking space”, given worries such as a large number of non-performing loans in the Chinese banking sector, a mis-allocation of capital and rising leverage across the whole economy.
Rebecca Jiang, one of Fidelity’s China-based analysts, said in a presentation with Nicholls: “I do have a cautious view on the Chinese banking sector and believe it is an uninvestable sector for long-term investors - at least at the moment.”
“I believe we need to see a few things happen - including better capital allocation and defaults needing to happen, just to move the implicit guarantee that the financial institutions are currently bearing. We also need to a deleveraging of the entire banking system.”
“To sum up, I think it’s difficult to justify investing in a bank, despite the seemingly cheap valuations.”
Nicholls notes that IT is an area which has experienced “a lot of growth” in recent years in China.
His investment trust has Tencent, the Chinese investment holding company with subsidiaries active in mass media, entertainment, internet and mobile phone value-added services, as its largest holding.
Alex Zhang, an analyst at Fidelity, said: “One of the interesting ideas within China’s IT sector is 21vianet, which is an internet data centre company. Internet usage is growing very fast in China, which will drive a 35 to 40 per cent [expansion] in internet data traffic into the next five years and drive tremendous demand for the internet data centre.”
“As one of the largest private internet data centres in China, 21vianet is well positioned to benefit from ongoing telecom reform and I believe in the next 12 months they will get their broadband licence, which will help them to cut 50 per cent of bandwidth cost and drive up gross margins from 29 per cent to 39 per cent in the next three years.”
IT is one of Fidelity China Special Situations’ largest overweights, with 24.2 per cent of the portfolio allocated to the sector compared with 13.3 per cent of its benchmark.
Fidelity China Special Situations’ largest sector bet is in consumer discretionary stocks, which account for 29.8 per cent of the portfolio.
This is significantly overweight the benchmark weighting of just 5.3 per cent.
Within this theme, Nicholls is investing in companies that will benefit from the rise of leisure travel among the Chinese consumer.
The investment trust has a 2 per cent allocation to China Lodging, which the manager describes as being “a bit like an early-stage Travel Lodge”.
Fidelity analyst Xing Hu said: “Leisure travel in China is a very powerful long-term theme. When you think about air travel in China, the average Chinese only travels just over one-tenth what the average American travels.”
“And if you look China’s demographics, there is a population spike at about the mid-20s and these are the incremental travellers in China.”
“When mid-20s people travel, they tend to be very price sensitive and this is where China Lodging comes in. China Lodging is a Chinese economy hotel that has well over 1,000 hotels in China and are growing at over 400 hotels a year.”
Fidelity China Special Situations is also playing the opportunities thrown up by the rise of private education in China, which the manager thinks is “clearly an interesting area”.
It holds New Oriental Education, which is the country’s largest private education company.
Fidelity analyst Monica Li said: “Twenty per cent of the Chinese population is below the age of 25, which means they spend a lot of time studying.
They are not only studying in school but in after-school tutoring institutions so this is a huge market with annual sales of over 200 billion renminbi [£19.5bn] – too big to ignore.“
“I think the best way to participate in this space is through investing in New Oriental.”
The share price has gone up by over 30 per cent in the past 12 months and I think it should continue to be our core holding in the future to help us benefit from the resilient growth in the Chinese education sector in the years to come.”
Founded in 1993, New Oriental has a network of 56 schools, 703 learning centers, 31 New Oriental bookstores and more than 5,000 third-party bookstores and over 16,500 teachers in 50 cities, as well as an online network with around 9.2 million registered users.
Since Nicholls took over Fidelity China Special Situations from Anthony Bolton in April 2014, the trust has returned 11.29 per cent - compared with the 13.49 per cent rise in the MSCI China and the 16.95 per cent gain by the average IT Country Specialists Asia Pacific member.
Performance of fund vs sector and index over manager tenure
Source: FE Analytics
The trust is currently trading on a discount of 10.7 per cent, according to AIC figures, and has a total expense ratio of 1.70 per cent.
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