EDITOR NOTE: Warren Buffett is famous for saying “don’t bet against America.” And those words of wisdom from the Oracle of Omaha rang true for decades, perhaps even to this day. But it’s a word of caution, and in today’s economic context, it isn’t necessarily a formula for success. The world's central banks have been de-dollarizing for some time. They essentially want to dump the assets that you hold in your bank; the assets you receive every month as income. What you have, most of the world doesn’t want. Even one of America’s biggest financial companies--Fidelity Investments, specifically Fidelity China Special Situations--is hedging US dollar and equity exposures as illustrated in the product below. All eyes are on China. Confidence in China’s capacity to outpace the US in technology, economic growth, trade dominance, and reserve currency status is gaining plenty of steam. And for good reason. Their government is not stuck in a viciously perpetual cycle of currency debasement and massive fiscal spending. They reached the post-COVID mark well before the rest of the world, and their economy was capable of growing when all other economies faltered. China will soon be the world’s most dominant superpower--economically and militarily. The yuan may soon be the world’s new reserve currency. The dollar will soon be of secondary or tertiary status. And all the while, physical gold will still remain the supreme monetary asset to hold through this transition (as it has been over the last 5,000 years).
Fidelity China Special Situations (FCSS) aims to deliver long-term capital growth from a portfolio of stocks listed mainly in China and Chinese companies listed abroad.
Fidelity China Special Situations key stats
* including income. As at 9 December 2020
Manager Dale Nicholls focuses on consumer-led sectors, which have the greatest exposure to China’s growth prospects and he sees many great investment opportunities, especially among lesser-known, smaller-cap stocks and unlisted
companies. Nicholls believes these businesses are driving innovation and change but are often undervalued.
FCSS has delivered significant outright returns and outperformance of its MSCI China benchmark and the UK market since the fund’s inception in 2010.
FCSS has delivered positive absolute returns and outperformed its benchmark over both the short term and longer term.
Over the three months to end November 2020, FCSS returned 17.4% on a share price basis and 8.4% on a NAV basis, compared to a benchmark total return of 5.6%. It has also outperformed its benchmark over one, three, five and 10 years.
In addition, the trust has outperformed the MSCI China Small Cap index, the MSCI AC Asia ex-Japan index and the MSCI World index over one, three, five and 10 years, despite its heavy concentration of megacap US growth stocks.
FCSS has also outperformed the UK market over all periods except one month, which serves as a reminder to UK investors of the potential benefits of diversification away from their home market.
The top contributors to FCSS’s relative performance over the three months to end-October 2020 included FCSS’s overweight to China MeiDong Auto Holdings, thanks to its strong portfolio of luxury brands, its growing market share, strong revenues from aftersales service and an improvement in new car margins.
An overweight to KE Holdings, a provider of online and offline property brokerage and housing services, was another major contributor to performance; as was the overweight to Yadea, a major player in the e-bike and scooter market, which has benefited from a surge in demand as people seek to avoid public transport.
The trust’s non-index position in SenseTime, an unlisted tech company focused on artificial intelligence, also enhanced performance, as did underweight positions in China Construction Bank and China Mobile.
The managers’ view – China trends offer rich vein of opportunity and value
The post-pandemic recovery in the Chinese economy is gathering momentum and FCSS’s manager, Dale Nicholls, has been spending a lot of time analysing how different the world will look in the wake of the virus. Probably the most striking development the manager sees is the acceleration of the shift online in so many aspects of life, including e-learning, gaming and medtech, but particularly in fintech and e-commerce.
This has been a global trend, but Nicholls believes it is happening fastest in China, with what he calls “amazing” businesses such as Alibaba and Tencent (FCSS’s top two holdings) “dominating market share and leading the world”. He views Tencent’s strategy of linking with offline retailers via data sharing, instore collection points and other measures to entice potential customers as especially canny.
The other major theme that has been the focus of Nicholl’s attention for some time is the rise of China’s middle class. This mega-trend is driving domestic demand for a range of consumer goods and services.
The manager cited China’s auto sector as one beneficiary, which is already the biggest such market in the world but is still under-penetrated. Auto dealers such as China MeiDong Auto Holdings, (FCSS’s third largest holding), which focuses on premium international brands such as BMW, Porsche and Lexus, have performed strongly but still have great growth potential says Nicholls. He also expects wealth management, insurance and travel companies to be long-term beneficiaries of rising demand from China’s middle class and he sees a plethora of great investment opportunities, especially among smaller-cap and unlisted companies, which he believes are driving innovation and change in China.
Chinese stocks also offer great value said Nicholls: “China has five of the biggest stock markets in the world, yet shares are still significantly discounted versus the US market. Furthermore, small-cap companies are trading at discounts to larger-cap businesses.”
As in other markets, value stocks look particularly inexpensive. Nicholls welcomes the recent improvement in investor sentiment towards such stocks, which has partially reversed their underperformance, as FCSS has significant holdings in value names. “It is gratifying to see our views on these companies confirmed by a rise in valuations,” added Nicholls, who sees scope for the value gap to continue to close as investors recognise the potential of Chinese value and small-cap stocks.
In the manager’s view, investors should not be discouraged from taking advantage of Chinese investment opportunities by events such as the Chinese government’s recent steps to tighten regulation over fintech companies. He argues that such moves have been on the horizon for some time and are not surprising given the government’s concerns about the regulatory gap between the fintech companies and the traditional banks. The associated delay in the launch of Ant, the financial services arm of the Chinese tech giant Alibaba is likely to be temporary, in Nicholls’ view. Some see these tightening moves as a harbinger of wider restrictions.
The manager believes further regulation is likely to be focused on the anti-competition practices of e-commerce giants such as Alibaba and Tencent. He feels regulation poses a lesser risk for smaller companies and unlisted businesses. In fact, says Nicholls, smaller e-commerce players such as JD.com and Pinduoduo may even benefit, as larger competitors are forced to spend time and resources adapting to the new regulatory landscape.
Investment strategy – Pre-IPO opportunities for patient investors
Manager Dale Nicholls argued that the unlisted company space holds many of China’s most innovative and entrepreneurial companies and there is a huge amount of activity and opportunity at the pre-IPO stage for investors, such as FCSS, with patience and a long-term perspective. However, this sector is less well known, and extensive bottom-up research of the kind conducted by Fidelity is required to identify significantly mispriced opportunities. The manager is looking at a number of potential investments, especially in technology, healthcare and consumer-related areas, that are best placed to benefit from growing consumer demand, and he expects the overall weight of unlisted companies in the portfolio to be higher in six months’ time.
FCSS’s positions comprise shorts in individual stocks and put options on indices, to which the manager adds when volatility is low and put options are attractively priced. At end-October 2020, net market gearing (which nets off short positions) stood at 20.8%. This level of gearing, which is relatively high compared to FCSS’s peers, reflects the manager’s conviction in the portfolio and his desire to increase exposure to the many opportunities available in China.
At end October 2020, the portfolio’s largest holdings were in tech giants Alibaba (11.3%) and Tencent (10.4%), which are viewed by the manager as integral to the Chinese economy and thus remain core holdings. However, despite the size of these positions, they are also the portfolio’s largest underweights versus the benchmark.
FCSS’s largest overweights among its top 10 holdings are its out-of-index positions in China Meudong Auto (3.8pp overweight), the premium brand auto dealer, 21 Vianet (2.6pp overweight), China’s largest carrierneutral internet and data centre service provider and Skshu Paint Co (1.7pp). Its top 10 holdings also include notable overweight positions in Wuxi App Tech Co, an innovative pharmaceutical research and development provider, and pharmaceutical company Hutchinson China Meditech.
One of the largest changes to FCSS’s portfolio over the last year has been an increased exposure to insurance companies. This is consistent with Nicholls’ view that the insurance market has great potential for demand to increase, including but not exclusively, demand for health insurance. This sector’s long-term growth potential is not factored into share prices at current levels, according to the manager. The portfolio’s largest relative overweight positions on a sectoral basis are information technology, healthcare and consumer discretionary.
Within the consumer discretionary sector, the manager expects the travel industry to perform especially well, both in the near term as it continues to rebound from the global shutdown in travel and in the longer term, thanks to sustained demand growth from China’s burgeoning middle class. The manager prefers to gain exposure to this theme through the trust’s holdings of Trip.com and some hotel holdings with good business models and roll out of new premises. The portfolio does not have exposure to airports or airlines.
FCSS has positions in six unlisted companies, representing 5.8% of gross assets at end-November 2020. Nicholls believes investing in such companies gives the trust exposure to unique businesses with significant upside growth potential.
Unlisted holdings include Pony.ai, which is China’s leading autonomous driving technology company, with what the manager believes is a compelling story. It is one of the five leading global players in this potentially huge new market and Nicholls views its recent strategic partnership with Toyota as very significant.
FCSS’s other unlisted holdings include DGI International, the leading consumer drone manufacturer, which accounts for 70% of the global market, Didi Chuxing Technology, a ride-hailing app with a 90% market share, and SenseTime, an information technology company focused on artificial intelligence and computer vision. ByteDance, an internet technology company that owns the video-sharing app TikTok, completes the list. It is the fastest-growing company in history and, in the manager’s view, continues to create value. FCSS’s most recent unlisted company acquisition, made in November 2020, was Full Truck Alliance, a car and cargomatching platform.
Originally posted on What Investment