Dale Nicholls (pictured) has blamed a low exposure to the energy sector for the poor recent performance of Fidelity China Special Situations
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The investment trust released its interim results for the six months to 30 September, showing a decline in NAV (net asset value) of 9.1 per cent, compared with losses of 4 per cent from its MSCI China benchmark.
Nicholls said the main reason for this underperformance was that he does not hold energy stocks CNOOC and PetroChina, which rose on the back of the higher oil price. However, a number of his other portfolio holdings were also sharply marked down.
“Vipshop, a major e-commerce platform for apparel and flash sales, faced a challenging environment with strong competition and as yet little to show for its collaboration with Tencent Holdings and JD.com,” he said.
“Kingsoft, a software and internet service company, experienced delays in launching new online games, which brought a series of downgrades.”
Fidelity China Special Situations’ two largest holdings Tencent and Alibaba, which together make up a quarter of the portfolio’s assets under management, have also experienced major issues recently, with the former almost halving in value from its peak this year and the latter down by almost a quarter.
However, Nicholls retains his faith in the long-term prospects for both stocks; for example, he said that while Tencent Holdings reported its first drop in net profits for 13 years in August, this was a reflection of one-off issues.
“It announced that there would be delays in obtaining regulatory approvals for new mobile games which account for a significant part of its revenues,” he explained.
“This is a result of recent announcements of a review of regulation of this industry. We expect the regulatory position to become clearer in the coming months.”
Nicholls said that while the disappointing results and announcements sent the share price lower, the fundamental growth story remains unchanged and is closely linked to Chinese consumption trends, with one billion active users of its WeChat messaging service.
“The potential to monetise this customer base remains significant. We expect Tencent to retain its leadership position in the mobile games sector. It is possible that the new regulatory regime could strengthen its position.”
Moving on to Alibaba, Nicholls said that while a slowdown in China’s consumption is a concern, he does not see signs of a major adjustment, adding that its GDP growth rate remains the envy of most economies.
The manager added that Alibaba continues to consolidate its leading position in e-commerce in China and there remains significant potential to monetise its customer base.
“The decision to delay monetisation for the long-term health of its ecosystem was the main factor behind recently lowered earnings guidance,” he continued.
“Still, underlying growth of around 40 per cent remains enviable – there are few companies of this size globally achieving this rate of growth. A recent meeting with management in Hangzhou with our board supported my confidence around this strong mid-term growth outlook.”
He added: “Valuations are back to compelling levels when we consider the various parts of the business including its dominant position in cloud and financial services via Ant Financial.”
In terms of changes to the portfolio, Nicholls said he is focused on opportunities that arise during indiscriminate sell-offs. For example, he said certain sectors are particularly sensitive to market falls, such as insurance and investment companies, with valuations dropping to historically low levels that significantly discount their long-term growth prospects.
“Insurance is hugely underpenetrated relative to the West with demand coming from the growing middle class in China,” he added.
“The long-term prospects in capital markets, particularly for institutions, make securities firms very attractive at these prices.”
Nicholls said that while escalating trade tensions give cause for concern, a key component of his analysis is an evaluation of each company’s pricing power, “which is clearly important when we are looking at the effect of tariffs and a company’s ability to pass on higher costs”. The manager also pointed to data showing the companies in his portfolio derive just 1.5 per cent of revenues from the US but more than 93 per cent from Greater China.
Numis Investment Companies said that even though it has been a difficult period for absolute and relative returns for Fidelity China Special Situations, it continues to regard Nicholls highly.
“The portfolio positioning means that performance will be dependent on sentiment towards the Chinese consumer,” the group’s analysts said.
“Fidelity China Special Situations seeks to exploit the closed-ended structure via its active use of gearing, as well as exposure to mid/small caps and unquoteds. We believe it is an attractive vehicle for investors that are comfortable with the risk profile and it is currently trading above a 10 per cent discount.”
Data from FE Analytics shows Fidelity China Special Situations has made 94.72 per cent since Nicholls took charge in January 2014, compared with 104.96 per cent from its peers in the IT Country Specialists Asia Pacific sector and 69.79 per cent from the MSCI China benchmark.
Performance of trust vs sector and index under manager tenure
Source: FE Analytics
The trust is on a discount to NAV of 12.77 per cent, compared with 12.26 per cent and 14.05 per cent from its one- and three-year averages. It is 30 per cent geared and has ongoing charges of 1.22 per cent.