Fidelity China Special Situations: Government controls put into perspective

Hardman & Co

In this note, we give our view on Chinese government policies, putting into perspective their objectives, the potential risks and upsides, and how fundamentals and sentiment may be affected. We note both negative and positive market reactions to recent events. We also update investors on themes in recent notes, including i) economic forecasts (still showing to be well above developed economies’ growth and resilience), ii) regulatory risk (on hold for a while), and iii) the geopolitical environment (easing most recently). Stock selection is critical to FCSS’s performance, but, as a geared play, Fidelity China Special Situations plc (LON:FCSS) can be affected by market sentiment.

  • Recent events: At the end of October, markets were weak on, we believe, concerns about additional government intervention after the Party Congress. More recently, there has been a strong rally around easing of COVID-19 restrictions. We believe investors should focus on the long-term growth objectives outlined at the Party Congress and look through any restrictions.
  • Opportunities: Market dislocations create stock-specific pricing anomalies, which research by a long-established, large, local team can identify. As we have outlined in previous reports, FCSS’s access to Fidelity’s local and global research gives competitive advantages. We do not believe the market is anticipating the range of potential policy responses to any slowdown.
  • Valuation: Fidelity China Special Situations trades at an 8% 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 2.4%, 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, Fidelity China Special Situations 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 1.5x those of 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 8% discount to NAV.

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