Our recent notes explored why investor concerns over the whole Chinese market appeared overdone. With the recent rise in these markets, it appears that these disquiets have moderated. Accordingly, in this note, we consider why investors, having decided that they like China, would choose Fidelity China Special Situations plc (LON:FCSS) as their investment vehicle. We note that i) it has delivered superior returns, ii) Fidelity’s processes and infrastructure are the drivers to this outperformance, iii) it is a large, liquid closed-ended vehicle, offering whole market exposure, iv) it has falling, variable and relatively low fees, and v) it has delivered rising dividends over a decade. We have increased our FY’23-24 NAV estimates by ca.20p to reflect the recent strong performance.
- Superior returns: FCSS has delivered cumulative returns around 3x the local benchmark and the whole UK market (4x UK smaller companies) since inception. Critically, this is driven by the value added by Fidelity, whose stock selection and use of gearing have more than doubled the index growth. The benefit from compounding higher growth further enhances investor returns.
- Opportunities: FCSS’s access to Fidelity’s on-the-ground and worldwide research gives insights and identifies opportunities unavailable to local, regional and global competitors, most notably in the small-cap space. This is compounded by the way FCSS, as a Trust, is managed, with a flexible mandate accessing unlisted investments, through gearing and managing investor returns.
- Valuation: FCSS trades at an 11% discount to NAV. The discount has trended down since 2016, but it rose recently on regulatory, economic and geopolitical concerns. Peer ratings have been volatile (FCSS is in the pack), but FCSS’s performance is significantly better. The yield is now 2.3%, and buybacks have been done recently.
- Risks: Further regulation in China is a risk, but FCSS’s exposure appears limited. Geopolitics may affect sentiment, but FCSS is domestically focused. Sentiment can go against FCSS’s investment style. The economic outlook remains uncertain, as is the policy response to it. Returns may be expected to be volatile.
- Investment summary: In general, FCSS invests in the huge opportunities from New China, with growth in the middle classes, and supportive government policies towards domestic demand and innovation, expected to underpin attractive GDP growth. Fidelity’s stock-picking, gearing, being able to make illiquid investments and the compounding benefits from investment outperformance have seen total share returns more than 2.5x those of listed peers over 10 years. There are risks from further regulations, but these may also create opportunities. Investor appetite for FCSS’s style may vary, and investors should expect volatile returns. As noted, the share price is at an 11% discount to NAV.
