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Mark Dampier: A special situation in China

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There are times when I am reminded that time flies by faster the older you get. I recently had one such moment when I met Dale Nicholls, manager of the Fidelity China Special Situations plc. Unbelievably, the investment trust launched almost five years ago.

Following a short spell of poor performance in the trust’s early days, I cannot help but feel the media had some responsibility for scaring investors away at exactly the wrong time. The trust’s original manager Anthony Bolton took a fair amount of flack at the time – most of it unwarranted, in my view. Indeed, those of us who invested at launch have been rewarded so far: the trust’s share price has grown by 46.5 per cent, with dividends reinvested, against the benchmark MSCI China index return of 28.1 per cent.

Nicholls took over the trust on 1 April 2014. I continued to rate the trust and I am encouraged by the results so far. Over the new manager’s tenure the share price has risen by 30.7 per cent, in line with the performance of the MSCI China.

China seems to divide investors like no other nation. In the UK, prolonged negative sentiment towards it has contributed to the widening discounts seen on many trusts investing there. At the time of writing, Fidelity China Special Situations is trading on a discount of 13 per cent.

In our recent meeting, Nicholls touched on his wider economic views. I would point out, however, he places more emphasis on the prospects for individual companies when it comes to constructing the portfolio. Lately he feels more assured about the property market. He has seen a clear change in mentality from both buyers and developers, particularly within the major cities where developers are beginning to think about raising prices and where demand is picking up.

He is slightly more negative on debt levels. While the rate of growing debt is slowing, he would prefer it to slow at a faster rate. His major worry is that China ends up in a similar scenario as Japan, without full recognition of the correct number of non-performing loans. He does not own any major banks.

The opening up of China’s A-share market presents a big opportunity. The market is under-researched and full of companies unknown to many investors. Further extension of the Stock Connect programme and the inclusion of A-shares in the MSCI indices could also be potential catalysts for this area of the market. Opening the market has also boosted transaction volumes, benefiting brokers such as CITIC Securities and Haitong International, both held in the portfolio.

E-commerce remains a fantastic opportunity in China. Internet penetration is still only 50 per cent compared with more than 90 per cent in the West, meaning plenty of scope for growth. The trust’s largest holding is Tencent, China’s largest internet service portal.

Alibaba, similar to Amazon and eBay, was held in the trust before it listed on the stockmarket (and was initially purchased by Bolton). Nicholls has since taken some profits, which appears to have been the correct call as its latest results were a little disappointing and the stock had reached a fuller valuation.

Other sectors he favours include insurance, with holdings in companies such as Ping An Insurance. Again, compared to the West, penetration is low in this sector, which is driving demand growth. He has also invested in a number of railway companies, which are great source of strong cash flow and where investment is increasing.

The opportunity in China is a long-term story, which is still very much intact. Valuations are extremely attractive and the trust is forecast to see average earnings growth of 20 per cent over the course of this year. The trust also currently employs gearing of 26.7 per cent representing the manager’s confidence towards the market. Trading on a significant discount to net asset value, it offers true value to investors.

Mark Dampier is head of research at Hargreaves Lansdown 

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