Final Results
FIDELITY CHINA SPECIAL SITUATIONS PLC
Preliminary Announcement of Results For the period ended 31 March 2011
Chairman's Statement
RESULTS FOR THE PERIOD FROM 19 APRIL 2010 TO 31 MARCH 2011
NAV PER SHARE: +5.24%
SHARE PRICE: +10.00%
BENCHMARK: +3.30%
I have pleasure in presenting the first Annual Report for Fidelity China
Special Situations PLC and would like to take the opportunity to welcome all
our shareholders.
PERFORMANCE REVIEW
Over the period under review, China overtook Japan to become the world's second
largest economy, driven by its rapid transition from a predominantly export-led
economy to one that is increasingly influenced by domestic consumption. A key
focus of China's twelfth five-year plan is to boost the consumption power of
the less affluent by reducing the income gap between its citizens. This
supports the consumer-consumption focus of the Portfolio Manager's investment
thesis.
These structural changes have been managed through a period of volatility for
all equity markets, which has been amplified by sovereign debt concerns in the
Eurozone and rising commodity prices, in particular food and energy. These
issues have certainly heightened investor caution. Nevertheless, growth in the
Chinese economy has been above 8% per annum, despite continued tightening of
bank reserve requirements. This, along with interest rate rises imposed by the
Chinese Government, has impacted the domestic property market.
The main concern now is inflation, with the Chinese consumer price index
running at 5.4% for the year to March 2011. This is likely to lead the Chinese
government to implement a further round of tightening measures. Coupled with
significant wage increases, these in the long term may end China's days as the
cheap manufacturing base of the world.
Against this backdrop, your Board believes that the growth in size and
affluence of China's middle class - leading to a higher level of aggregate
disposable income - will be an ongoing driver of domestic consumption. We
expect that for this reason, the consumer-consumption story will continue to be
a central focus for the Company's investment portfolio.
Since the launch of the Company in April 2010, performance figures for the
period to 31 March 2011 are encouraging. They provide a solid platform on which
the Company can continue to achieve its investment objective of generating long
term capital growth for its shareholders.
In the period from 19 April 2010 to 31 March 2011, the Company's net asset
value (NAV) per ordinary share increased from 99.01p to 104.20p, an increase of
5.24%. This compares with a rise in our benchmark, the MSCI China Index, of
3.30%. In the same period, the market price of the ordinary shares increased
from 100.00p to 110.00p, an increase of 10%, and the ordinary shares traded at
an average premium of 5.30%.
As of 17 June 2011, being the latest practicable date prior to publication, the
NAV of the Company was 93.86p per share and the share price was 94.50p per
share, meaning that your shares were trading at a 0.68% premium to NAV.
DIVIDEND
As the Company's objective is to achieve long term capital growth, the Board
does not expect that dividends will constitute a material element of any return
to shareholders. However, in order to continue to qualify as an investment
trust, the Company is required by Chapter 4 of Part 24 of the Corporation Tax
Act 2010 not to retain more than 15% of the income it derives from shares and
securities.
This being the case, allowing for the number of shares eligible for a dividend,
the Board recommends a final dividend of 0.25p per share to be approved by
shareholders at the forthcoming Annual General Meeting.
The dividend will be payable on 5 August 2011 to shareholders on the register
on 22 July 2011 (ex dividend date 20 July 2011).
SHARE ISSUES
On 18 June 2010, the Company was admitted to the FTSE 250 Index in recognition
of the size of the Company's market capitalisation.
Since the Company's launch, the shares have generally traded at a premium to
their net asset value, reflecting demand for shares that is not satisfied by
sellers. This being the case, the Company issued a total of 38,750,000 ordinary
shares in separate issues during the period under review. A further 6,250,000
shares were issued after the period end.
In addition the Company issued 166,250,000 "C" shares of 100 pence each, which
were subsequently converted into 157,654,480 new ordinary shares on 1 March
2011. This issue was supported by existing shareholders who subscribed for 56%
of the issue.
At the General Meeting to approve the "C" share issue the Board received
consent to issue further shares. The Board may continue to issue shares at a
premium, in order to satisfy market demand, subject to shareholder approval at
the Annual General Meeting.
Qualified Foreign Institutional Investor (QFII)
On 26 November 2011, the Investment Manager of the Company was granted QFII
Status and a QFII quota through which the Company may invest in China "A"
Shares through the Investment Manager.
This facility allows the Portfolio Manager to invest directly into the
potential growth opportunities of the "A" Share market. The Company has now
fully funded its share of the quota (as required by State Administration of
Foreign Exchange of the PRC ("SAFE")).
THE BOARD
Board members who were appointed in February 2010 are subject to election at
the forthcoming Annual General Meeting of the Company.
On 1 March 2011, Mr Douglas Naismith resigned as a Director and Mr Gary
Shaughnessy was appointed to the Board. I would like to welcome Gary to the
Board and thank Doug for his valuable contribution to the Company. Mr
Shaughnessy will also be subject to election at the Annual General Meeting.
Since my appointment as Chairman of the Board, the last year has been both
challenging and fulfilling. The Board has held over twenty Board meetings and
overseen two successful share issues, which have created the largest investment
company listed on the London Stock Exchange providing direct exposure to China.
In October 2010, the Board visited China and Hong Kong to witness first hand
the investment opportunities there. During this visit it was clear that the key
asset of the Company and that of its shareholders is the breadth and strength
of Fidelity's investment team in Hong Kong, led by Anthony Bolton.
CORPORATE GOVERNANCE
As detailed in the Corporate Governance Statement on pages 25 to 30, the Board
follows the approach recommended by the Association of Investment Companies in
its Code of Corporate Governance.
The volume and impact of regulatory change remain challenging for boards of all
UK plc's. In particular, the uncertainties around the future of financial
regulation in the UK, the potential impact of the Retail Distribution Review
and the implementation of the Alternative Investment Fund Managers Directive
(AIFMD) will add to the complexity of the governance framework of investment
companies going forward.
The Board regularly reviews regulatory change to ensure that the Company's
governance arrangements meet best practice requirements.
THE ANNUAL GENERAL MEETING - 29 JULY 2011
The Annual General Meeting of the Company will be held at the Barbican Centre,
Silk Street, London, EC2Y 8DS, on Friday 29 July 2011 at 11.00am.
Our Portfolio Manager, Anthony Bolton will be attending the Annual General
Meeting and making a presentation highlighting the achievements and challenges
of the initial period and the prospects for the year to come.
John Owen
Chairman
17 June 2011
Manager's Report
When I wrote the first interim report in October last year I did so in a mood
of optimism - my transition to Hong Kong was going well and I had settled back
into a familiar fund manager's routine. I was enjoying meeting lots of Chinese
companies, interacting with our team of analysts and other fund managers who
follow China and reading lots of broker and other third party research. Most
importantly, the NAV was up about 15% from launch. I did preface my remarks by
saying it was still early days, however, and it is now clear that the fund's
first period has been one of two halves. About the time I wrote my report the
market and NAV peaked and the second half proved much tougher, with the market
falling until it made a low in mid March round the time of the C share issue.
There was some recovery in April but recently the NAV has returned to near
100p. The second half of the period and performance since the period end has
been disappointing for investors and me personally.
I still believe world equities are in a bull market and what we have recently
experienced in Chinese stocks is a normal pause in that cycle. I do not yet see
either the investor behaviour or market valuations that one would normally
associate with a bull market peak. In fact, given the extraordinary world
events in the first quarter of this year, markets have been remarkably
resilient, illustrating how bull markets typically climb a "wall of worry". As
I have maintained for some time, I still feel we are in a two-speed world where
growth in the developed economies will be below normal for several years - the
solution to the financial crisis has left them with debt problems that will
hold back growth for the foreseeable future. The US, Europe and Japan have
major challenges ahead and, although emerging markets will not be immune to the
effects of this, I believe the relatively higher growth they offer will be
increasingly attractive to investors. For the first part of 2011 investor flows
have returned to developed markets and emerging market funds have seen
redemptions. I believe this is a temporary pause and flows will return to
emerging markets.
One of the fascinating things about China is the fact that investors' attitudes
to it are very polarised; it is like one of those optical illusions where some
viewers perceive a smiling face and some a sad one - the same picture can
provoke two very different interpretations. Some see China as the main driver
of Asian growth, on its way to becoming the biggest economy in the world, while
others are concerned about excessive credit growth and inflation, property and
bad debt problems. Probably the truth lies somewhere between these two
extremes. I want to spend some time in this report on the negative case as,
although many of the concerns are valid, I believe some of the conclusions
being drawn are wrong. Like any investment proposition, China is not without
risks but I continue to believe that the case for investing is compelling.
INFLATION
My first observation is that in today's two-speed world most emerging markets
are probably going to have to live with higher levels of structural inflation
than in the recent past. Indeed, the actual level of inflation in China is
probably higher than the 5.4% official figure suggests, maybe more like high
single digits. China's new five year plan is targeting annual real wage
increases of at least 7% and this does not sit easily with an official
inflation target of 4%, which I believe will probably be increased in the
future. That said, the Chinese authorities have many powers to influence
inflation - powers like price controls which are generally not available in
other countries. We have already seen this with official or unofficial price
controls on a number of products. Recent evidence seems to suggest that food
inflation which makes up 70% of China's official CPI is at or past its peak,
although core inflation is creeping up. I would not want to say that inflation
is not a problem but I do not think it will stop the bull market unless it gets
completely out of control. The authorities must tread a delicate path between
slowing the economy to alleviate inflationary pressures and suppressing growth
too much but I believe they will strike the right balance. I am expecting
growth to fall back to 7-8% compared with last year's 10%, but that is still a
very attractive level relative to the developed world.
PROPERTY
Residential property prices in most Chinese cities have been in a generally
rising trend for a number of years and affordability looks pretty stretched.
Because of the negative public opinion associated with this, the Chinese
authorities last year imposed a number of measures to cool demand, including
unprecedented controls in some cities on buying multiple properties and
purchases by individuals not resident in that city. These measures have removed
a lot of the short term speculative money from the market. The Government has
also embarked on a very ambitious social housing programme (10 million units
this year and a total of 36 million over the next five years). A number of the
negative reports I have received on China suggest that there are several empty
cities in China; this may indeed be the case but the Chinese often build
infrastructure well in advance of when it is needed and I expect most of the
empty cities to fill up in time. These reports also suggest there are as many
as 65 million empty apartments. I am unable to confirm a source for this figure
and the research I have seen suggests a figure significantly smaller than this.
Although empty, these properties are all owned by individuals who chose to keep
them as empty shells (there is not a huge backlog of unsold apartments owned by
developers). The key question is whether owners try to sell out if, as looks
likely later this year, we experience a period of falling property prices. My
view is that most will hold on, seeing property as a longer term investment
rather than a short term speculation. Also, the mortgage debt against these
properties is generally not high so they are unlikely to be forced sellers. The
long term demand picture for residential housing is still very favourable.
BAD LOANS
China has experienced over two years of rapid credit growth. Government
measures such as raising interest rates and increasing reserve requirements
appear to have led to a slow down in the rate of growth, although lending
outside the banking system still appears to be growing fast. Once credit has
been expanded strongly it is always difficult to wean banks, companies and
individuals off it. That said, credit at the individual level is still very low
in China by international standards. One area that observers are particularly
concerned about is loans by banks to vehicles set up by local Governments to
help finance infrastructure and other local projects. Listed banks have lent
RMB 6.25 trillion to these vehicles. The bank regulator (CBRC) has required all
banks to look at such loans very closely and it appears as if up to 20% are at
some sort of risk of not being repaid. The other thing that worries investors
is that local Governments' main source of income is usually selling land they
own to developers. If there are problems in the property market, it may become
more difficult for them to sell land, which would restrict their financing
flexibility. I agree that this is a risk, particularly from 2012 when many of
these loans become due. However, I believe the central Government will step in
to help the local Governments through any temporary difficulties.
Investors are rightly concerned about inflation, the property market and credit
growth, but for the reasons I have outlined here I believe the conclusions they
have drawn are too pessimistic. On a more positive note, the authorities have
launched an ambitious and challenging new five year plan which envisages a
major transition of the economy away from low value manufactured exports
towards domestic consumption and the growth of services. They have put specific
targets on how much of GDP will in the future come from these two areas.
Interestingly, this very much endorses the strategy that I have pursued in
managing the fund, with my main focus being on these two areas. I do not think
anyone should underestimate the challenges from this major change of course for
the economy, with many workers having to retrain for completely new careers in
new places. However, the pragmatism and flexibility of Chinese workers and
their managers impresses me. The five year plan also underwrites a further
phase of urbanisation in China. Some people worry about the demographics of
China, with an aging population due to the one child policy. I think in maybe
ten years time this could be a problem but today the continued shift of workers
from rural areas to cities is the more important trend.
Finally, the five year plan underwrites the so called "S curve" effect where
domestic growth speeds up once a certain level of GDP per head is exceeded. The
growth in the China consumer story remains for me the dominant investment theme
which will continue to exert a positive influence on markets long after the
short term concerns have been resolved.
KOREA
One other risk in the region that has particularly concerned me is the
political situation between North and South Korea. We have seen several hostile
acts from the North on the South and my concern is that, if this continues,
next time the reaction of the South may be to retaliate. Such an event I
believe would, at least in the short term, be very worrying for investors in
the region. I think Chinese equities would be affected by this. Because of my
concern I have purchased out of the money put options on the Korean index to
protect about 25% of the fund's gross assets. Like any form of insurance it is
something that I hope will not be needed. The cost of these options has been
the largest negative contributor to the fund's performance during the period. I
have recently renewed these options for a further six month period.
GEARING
The Company has two types of gearing. The first is a bank debt facility of
US$100m (post the C share issue increased to US$150m). The debt is in US$
rather than HK$ as I believe there is a possibility of the Hong Kong US dollar
peg being removed at some stage and the HK$ moving up against the US$. The
second form of gearing is through derivatives principally via contracts for
difference against some of the largest holdings.
PORTFOLIO
The fund continues to be mainly focused on the Chinese consumption and service
sectors with about a third of the fund in consumer sectors, like retailers,
luxury cars, food and drink, consumer products, internet and hotels and
restaurants, and about half the fund in service businesses, such as financial
services, mobile telephony, healthcare, IT services and education. The rest of
the fund is in materials companies (gold and paper), domestically-orientated
manufacturing companies and some investment companies. The portfolio remains
very underweight in most exporters, and infrastructure and commodity names,
including oil shares. This low oil exposure has hurt the fund this period but
for the moment I am maintaining the position. On commodities in general, I
think the valuations are high, they are very popular and over-owned and
therefore risky. I do not think they reflect the slowing growth in China and
low growth in the rest of the world. It is interesting that Glencore, one of
the most successful commodity trading houses, has chosen now to list when,
maybe, a number of commodity prices are near a peak. Oil is different from
other commodities, having a political angle that the others largely do not. We
will have to watch the situation in the Middle East carefully and especially
Saudi Arabia. I also view gold differently from the other commodities as it has
characteristics more like a currency. In a world where so many currencies have
problems, some exposure to gold makes sense to me.
Within financials, the main exposure is to Hong Kong-based banks (about 12% of
the gross assets) and property companies (about 5%) rather than mainland banks
and property companies. The fund's only exposure to the mainland residential
property market is through two estate agent companies (about 1% of the fund).
Because of the Government's tightening measures and the uncertainties about the
banks' bad loans and the poor short term outlook for the property market on the
mainland, I have preferred the Hong Kong companies. Hong Kong banks are
benefiting from good loan growth, the prospect of higher margins and the
effects of the internationalisation of the RMB. This should be a new source of
revenue as the Hong Kong-based banks are in pole position to benefit from this
trend.
The majority of the fund is invested in private companies rather than state
owned enterprises. Private companies are generally more dynamic although they
can also be more risky. Also, 44% of the fund is in small companies with a
market capitalisation below £1 billion, 28% in medium-sized companies (£1-5
billion) and another 28% in large companies over £5 billion. I continue to feel
the medium-sized and smaller companies offer some of the best potential and
they are also the least well researched.
Fidelity has received its QFII licence and clearance to invest so, since the
period end, I have been using this quota to invest in Chinese "A" Shares. Most
of our quota has been used to replace the broker provided QFII that we have
used to date. The majority of the fund's "A" share exposure is in financial
shares, where the "A" shares often sell at a significant discount to the Hong
Kong-listed shares of dual-listed companies (companies listed in both the
mainland and Hong Kong). In most other areas, I continue to find the "A" shares
expensive relative to the shares of similar companies listed in Hong Kong or
the US. At the period end, 66% of the gross assets was in Hong Kong-listed
shares, 8.5% was in mainland-listed "A" or "B" shares, about 15% in US-listed
shares and 7.5% in Chinese exposed companies in other markets. As well as
underlying exposure to RMB through investments held, the Company also had
additional RMB exposure through RMB foreign exchange contracts.
In summary, I remain as convinced as ever by the long-term case for investing
in China. In the short term, there are challenges as the Chinese authorities
try to effect a soft landing for their economy, but I believe they will
succeed. I expect investment flows to resume their trend out of the developed
world into emerging markets like China; this may lead, at some stage, to
valuations going well above fair value. I hope that with the help of our
excellent team here in Hong Kong, we can continue to uncover the companies that
are best placed to benefit from the ongoing transformation of China's economy.
Anthony Bolton
17 June 2011
Enquiries:
Chris Davies, FIL Investments International - 01737 837 723
Christopher Pirnie, FIL Investments International, Company Secretary - 01737 837929
For Press Enquiries, please contact Anne Read on 020 7961 4409 or 07850 549839
Income Statement for the period from 19 April 2010 to 31 March 2011
revenue capital total
Revenue £'000 £'000 £'000
Investment income 9,447 - 9,447
Other income 23 - 23
Net derivative income 30 - 30
Total income* 9,500 - 9,500
Gains on investments designated at fair
value through profit or loss - 32,177 32,177
Losses on derivative instruments held
at fair value through profit or loss - (12,211) (12,211)
Foreign exchange losses on other net
assets (39) (513) (552)
Foreign exchange gains on bank loans - 3,004 3,004
Total income and gains 9,461 22,457 31,918
Expenses
Investment management fee (3,746) (3,746) (7,492)
Other expenses (2,435) - (2,435)
Profit before finance costs and
taxation 3,280 18,711 21,991
Finance costs
Interest on bank loans (523) (523) (1,046)
Profit before taxation 2,757 18,188 20,945
Taxation** (426) - (426)
Net profit after taxation for the
period 2,331 18,188 20,519
Earnings per ordinary share 0.47p 3.67p 4.14p
The Company does not have any income or expense that is not included in the net
profit for the period. Accordingly the net profit after taxation for the period
is also the total comprehensive income for the period and no separate Statement
of Comprehensive Income has been presented.
The total column of this statement represents the Income Statement of the
Company and is prepared in accordance with IFRS. The revenue and capital
columns are supplementary and presented for information purposes as recommended
by the Statement of Recommended Practice issued by the Association of
Investment Companies.
All of the profit and total comprehensive income is attributable to the equity
shareholders of the Company. There are no minority interests.
All items in the above statement derive from continuing operations. No
operations were acquired or discontinued in the period.
The Company was incorporated on 22 January 2010 and operations commenced when
its shares were listed on the London Stock Exchange on 19 April 2010.
* 31.03.11
£'000
Income from investments designated at fair value through profit or
loss
Overseas dividends 8,783
Overseas scrip dividends 664
9,447
Other income
Deposit interest 12
Income from Fidelity Institutional Liquidity Fund plc 11
23
Net derivative income
Income received on long CFDs 68
Less: expenses paid on long CFDs (38)
30
Total income 9,500
** relates to overseas taxation only
Statement of Changes in Equity for the period from 19 April 2010 to 31 March
2011
share
share premium other capital revenue total
capital account reserve reserve reserve equity
£'000 £'000 £'000 £'000 £'000 £'000
Proceeds from
offer for
subscription
and placing 4,600 455,400 - - - 460,000
Fees and
expenses of
the offer for
subscription
and placing - (3,168) - - - (3,168)
Cancellation
of share
premium
account1 - (452,232) 452,232 - - -
Issue of
ordinary
shares 387 42,262 - - - 42,649
Additional
share listing
costs2 - (200) - - - (200)
Proceeds from
"C" share
offer and
placing 1,577 164,673 - - - 166,250
Fees and
expenses of
the "C" share
offer and
placing - (2,087) - - - (2,087)
Net profit
after
taxation for
the period - - - 18,188 2,331 20,519
Equity
shareholders'
funds at 31
March 2011 6,564 204,648 452,232 18,188 2,331 683,963
1 Court approval was given on 21 April 2010 for the Company's share
premium account to be cancelled. As a result £452,232,000 was transferred to
the other reserve account. This is a distributable reserve.
2 Costs associated with block listing application fees charged by the
London Stock Exchange.
The Company was incorporated on 22 January 2010 and operations commenced when
its shares were listed on the London Stock Exchange on 19 April 2010.
Balance Sheet as at 31 March 2011
Company No. 7133583
£'000
Non current assets
Investments designated at fair value through profit or
loss 720,287
Current assets
Derivative assets held at fair value through profit or
loss 2,729
Amounts held at futures clearing houses and brokers 3,280
Other receivables 7,388
Cash and cash equivalents 25,184
38,581
Current liabilities
Derivative liabilities held at fair value through profit
or loss (1,582)
Bank loan (62,013)
Other payables (11,310)
(74,905)
Net current liabilities (36,324)
Net assets 683,963
Equity attributable to equity shareholders
Share capital 6,564
Share premium account 204,648
Other reserve 452,232
Capital reserve 18,188
Revenue reserve 2,331
Total equity shareholders' funds 683,963
Net asset value per ordinary share 104.20p
The financial statements were approved by the Board of Directors on 17 June
2011 and were signed on its behalf by:
John Owen
Chairman
17 June 2011
The Company was incorporated on 22 January 2010 and operations commenced when
its shares were listed on the London Stock Exchange on 19 April 2010.
Cash Flow Statement for the period from 19 April 2010 to 31 March 2011
£'000
Operating activities
Cash inflow from investment income 7,736
Cash outflow from net derivative income (26)
Cash inflow from other income 21
Cash outflow from Directors' fees (105)
Cash outflow from other payments (6,645)
Cash outflow from purchase of investments (1,066,951)
Cash outflow from purchase of derivatives (16,857)
Cash inflow from sale of investments 380,884
Cash inflow from sale of derivatives 3,499
Cash outflow from amounts held at futures clearing houses and (3,280)
brokers
Net cash outflow from operating activities before servicing of (701,724)
finance
Servicing of finance
Cash outflow on interest on bank loans (1,040)
Net cash outflow from operating activities and servicing of finance (702,764)
Financing activities
Cash inflow from the offer for subscription and placing 460,000
Cash inflow from the issue of ordinary shares 42,649
Cash inflow from the "C" share offer and placing 166,250
Cash outflow from the costs of the offer for subscription and (3,168)
placing
Cash outflow from the costs of the issue of ordinary shares (200)
Cash outflow from the costs of the "C" share offer and placing (2,087)
Cash inflow from bank loan 62,013
Net cash inflow from financing activities 725,457
Increase in cash and cash equivalents 22,693
Reconciliation of cash and cash equivalents
Net cash inflow from cash and cash equivalents 22,693
Effect of foreign exchange gains 2,491
Cash and cash equivalents at the end of the period 25,184
The Company was incorporated on 22 January 2010 and operations commenced when
its shares were listed on the London Stock Exchange on 19 April 2010.
The above statements are prepared in accordance with International Financial
Reporting Standards ("IFRS"). This preliminary statement, which has been agreed
with the Auditor, was approved by the Board on 17 June 2011. It is not the
Company's statutory financial statements. The statutory financial statements
for the period ended 31 March 2011 have been approved and audited but have not
yet been filed with the registrar of companies. The statutory financial
statements for the period ended 31 March 2011 has received an unqualified
audit report, does not include a reference to any matters to which the Auditor
drew attention by way of emphasis without qualifying the report and does not
contain statements under section 498(2) and (3) of the Companies Act 2006.
The annual report and financial statements will be posted to shareholders as
soon as is practicable and in any event no later than 27 June 2011.
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