Final Results
Fidelity China Special Situations Plc
Final Results for the year ended 31 March 2016
Financial Highlights:
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Fidelity China Special Situations PLC outperforms strongly in a volatile period for markets, largely through skilful stock selection
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NAV per Share total return: +0.02%, representing outperformance of 16.19% against the MSCI China Index
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Share Price total return: -4.53%
“In a year when the Benchmark Index, MSCI China Index in sterling terms, fell by 16.17%, the portfolio outperformed very strongly in a volatile period for markets, largely through skilful stock selectionâ€: John Owen, Chairman
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38.5% increase in recommended dividend: 1.80 pence (2015: 1.30 pence)
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Company seeking to revise the limit of unlisted investments from 5% to 10% of Gross Assets to allow it to react if investment opportunities occur
“The Company aims to provide shareholders with an exposure to China’s growth story to be held over the medium term. I am convinced that the Chinese middle class continues to grow both in wealth and in number and much of the Company is invested in businesses providing goods and services to the rising Chinese consumer market. However, I also look for undervalued opportunities whether in the SOE sector or in oversold parts of the market. Given the investment opportunities in China, I remain confident in our ability to grow the NAV of the Company over the medium-termâ€: Dale Nicholls, Portfolio Manager
Chairman’s Statement
I have pleasure in presenting the sixth Annual Report of Fidelity China Special Situations PLC for the year ended 31 March 2016. This is my final Chairman’s report before stepping down at the Annual General Meeting on 22 July 2016.
Over my tenure as Chairman, we have striven successfully to make the Company a cornerstone investment for those seeking Chinese equity exposure, and the Board will continue to do so.
China is now, by some measures, the largest economy in the world, and the Board believes that when building a balanced portfolio, the country is simply too big to ignore. For those investing in a well-balanced global portfolio for the long term, either professionally or privately, a proportion held in China must warrant consideration; and the Board believes that Fidelity China Special Situations PLC is the right vehicle to provide this exposure. The Board continues to work with the Manager to ensure that the Company remains well positioned to meet this need, by focusing on the development of “New China†and the rebalancing of China’s economy.
Performance Review
For the year under review, the Company’s NAV total return increased by 0.02% while the share price total return fell by 4.53%. However, these numbers do not tell the full story. In a year when the Benchmark Index, MSCI China Index in sterling terms, fell by 16.17%, the portfolio outperformed very strongly in a volatile period for markets, largely through skilful stock selection. I am pleased that the Portfolio Manager has been able to navigate the portfolio successfully through this period. In May 2015, the Company’s NAV and share price reached an all-time high, but subsequent market movements have led to a fall back to levels similar to the start of the reporting period.
Negative sentiment towards China, led by concerns over its economic growth, movements in RMB and capital market policy have caused volatility since May 2015. These points are addressed in the Portfolio Manager’s Report, but the Board continues to share the Portfolio Manager’s positive outlook for structural growth in areas including Chinese consumption and technology. There is a continuing focus on the GDP number reported from China, but we believe that a slowing economy is the natural path for the country as it develops into one of the largest and most sophisticated economies in the world. It is unrealistic to expect an economy as big as China to grow over the next decade at the same pace as during the last decade. Instead, investors should focus their investments in areas that will drive China’s next stage of development and play into the structural changes stemming from an increasing middle class and more advanced manufacturing and services sectors. This requires on-the-ground research and careful stock picking, and the Board has been impressed with Dale Nicholls’ ability to do this for our investors.
Due Diligence visit to China
In October, the Board carried out its regular due diligence visit to China, visiting Fidelity International’s offices and meeting with its analysts. We made several visits to Chinese companies, reviewed Fidelity’s investment processes and continued to see at first-hand experience of developments in the country. We were greatly encouraged by what we saw throughout a busy few days and came away with a reinforced view that the rebalancing of China’s economy to be more consumer-led will be the engine of its growth for the coming years.
Gearing
The Company renewed its multicurrency revolving credit facility agreement with Scotiabank Europe PLC for US$150,000,000 on 14 February 2014 for a further three years. The loan has been fully drawn down throughout the period under review.
To achieve further gearing, the Company uses Contracts For Difference (“CFDsâ€) on a number of holdings in its portfolio. Further details are in Note 19 in the Annual Report.
At 31 March 2016, the Company’s gearing, defined as the Gross Asset Exposure in excess of Net Assets, was 27.2% (2015: 25.9%).
Change in Investment Policy
The Company under its current Investment Policy is permitted to invest 5% of Gross Assets in unlisted securities issued by companies which carry on business, or which have significant interests, in China or Hong Kong. The Board is seeking to revise this limit to 10% of Gross Assets as there are now more potential unlisted investment opportunities and the revised limit would allow the Portfolio Manager to react quickly if investment opportunities occur.
Following the successful initial public offering of Alibaba in which the Company invested from an early stage, there has been a trend for companies to raise capital in private markets and to list on a public stock exchange after their development has progressed.
The proposed change to the Investment Policy is shown in the Appendix in the Notice of Meeting in the Annual Report. A resolution to amend the Investment Policy accordingly is being proposed at the Annual General Meeting on 22 July 2016, as detailed in the section on the Annual General Meeting in the Annual Report.
Dividend
The Board recommends a dividend of 1.80 pence (2015: 1.30 pence) per Ordinary Share for the year ended 31 March 2016 for approval by shareholders at the forthcoming Annual General Meeting. This represents a 38.5% increase on the 1.30 pence paid in respect of the prior year.
The dividend will be payable on 26 July 2016 to shareholders on the register on 24 June 2016 (ex-dividend date 23 June 2016).
Shareholders may choose to reinvest their dividends to purchase more shares in the Company. Details of the Dividend Reinvestment Plan are set out in the Annual Report.
Discount Management and Treasury Shares
During the year, the discount widened which the Board believes reflects a more cautious attitude towards China amongst investors, notwithstanding the excellent performance of the NAV compared to the Benchmark Index. The Board’s belief at present is that the discount is best addressed by buying back the Company’s Ordinary Shares when appropriate, and during the year, 3.1% of the Ordinary Shares in issue (excluding Treasury Shares) has been repurchased during the year under review, purchased at an average discount of 16.4%. All shares have been repurchased into Treasury. These buybacks will have benefited all shareholders as the NAV per share has been increased by purchasing shares at a discount.
We will be seeking to renew the annual authority to repurchase up to 14.99% of the Company’s shares at the forthcoming Annual General Meeting, as we have done each year previously, and assure shareholders that we will keep both the discount and the share repurchase programme under review. The Directors regularly review and discuss the discount and the ways in which it might be reduced so that the shares can trade at a level closer to the NAV. The Directors also monitor market practice amongst peer group trusts and take regular advice from the Company’s Broker. Since the year end, a further 575,000 Ordinary Shares have been repurchased into Treasury at an average discount of 18.4%.
Board of Directors
After serving as Chairman of the Company since launch, I will retire at the conclusion of the forthcoming Annual General Meeting. I have enjoyed serving on the Board and would like to thank shareholders, my fellow Directors and the team at Fidelity for all the support I have been given.
I am delighted to say that Nicholas Bull, Senior Independent Director, will succeed me as Chairman. Nicholas, like me, has been on the Board of the Company since its launch in 2010.
The Board was pleased to welcome Vera Hong Wei as a new member of the Board with effect from 24 March 2016. Vera is a Chinese national with 18 years’ experience in the Chinese financial industry which spans the central bank, commercial bank and asset management sectors. Further details are included in her biography in the Annual Report.
Andrew Wells will not be seeking re-election at the Annual General Meeting on 22 July 2016 as he is now focusing on a new role within the Fidelity business. I am most grateful to Andrew for his valuable work for the Board, and the shareholders, during his time on the Board. I am pleased to welcome John Ford as a new member of the Board on 22 July 2016; he is FIL’s Global Chief Investment Officer for Fixed Income, Solutions and Real Estate. John’s biography can be found in the Annual Report.
Vera and John will both be subject to election by shareholders at the forthcoming Annual General Meeting and in accordance with the UK Corporate Governance Code for Directors of FTSE 350 companies, all the other Directors are subject to annual re-election at that time. The Directors’ biographies can be found in the Annual Report. The Directors have a wide range of appropriate skills and experience to form a balanced Board for the Company.
Viability Statement
In accordance with the 2014 UK Corporate Governance Code, the Directors are now required to report on the viability of the Company over a longer period than the twelve month period required by the Going Concern statement which is in the Annual Report. This new statement can be found in the Strategic Report in the Annual Report.
Change of Auditor
As reported in the Half-Yearly Report for the period ended 30 September 2015, and in line with best corporate governance practice and EU regulations on mandatory audit rotation, a formal audit tender process was undertaken by the Company in the reporting year. A number of audit firms were considered and Ernst & Young LLP was selected as the Company’s new independent Auditor for the year ending 31 March 2016. The appointment is subject to approval by shareholders at the forthcoming Annual General Meeting.
The Annual General Meeting – 22 July 2016
The Annual General Meeting of the Company will be held at Merchant Taylors’ Hall, 30 Threadneedle Street, London EC2R 8JB on Friday 22 July 2016 at 11.00 am.
The Board is looking forward to having the opportunity to speak to shareholders. Dale Nicholls, the Portfolio Manager, will be making a presentation on the year’s results and the prospects for the Company for the year to come. We encourage you to join us on this occasion.
John Owen CMG MBE DL
Chairman
1 June 2016
Portfolio Manager’s Review
This year has witnessed significant swings in sentiment as China’s stock markets enjoyed and endured both bull and bear market runs. Whilst there were some spectacular stock moves last year, some this year were even more severe. Against this backdrop, the Company’s NAV was broadly flat recording a 0.02% total return. The MSCI China Index, by contrast, fell by 16.17%. Unfortunately, negative sentiment towards China weighed on the Company’s share price, which fell 4.53%. This means that the share price outperformed the Benchmark although the discount to NAV increased. Taking a three-year view, the numbers remain strong, with the Company’s NAV up 73.70% and its share price up 52.34% against the MSCI China Index return of 8.67%. (All figures on a total return basis)
Market View
China’s stock markets have been a tough place for investors in the year under review which ended on 31 March 2016. Sentiment was negatively impacted by confusing policy messaging, growth concerns and currency depreciation in the second half of 2015. It is undeniable that some investor concerns are valid. For instance, some of China’s old growth drivers are struggling and headline growth is undoubtedly moderating as China’s economy matures. Debt levels also continue to expand at a significant pace and, in my view, banks are probably understating the true extent of their non-performing loans. The longer this rapid growth in debt continues the greater the longer term risks for the economy.
Policy and communication have been dominant swing factors for markets over the review period and have had a significant impact on market confidence in China. There is room for improvement here and it will take some time for investors to regain confidence in the authorities’ ability to manage China’s financial system. In the middle of last year, the government cracked down on margin finance (investor’s borrowing money from financial institutions to invest in the market). While it is sensible to regulate margin financing, there were questions as to why it was able to grow to such a level in the market (around10% of market-capitalisation in the middle of 2015 was assumed to be from margin finance) and why the consequent market intervention was so aggressive and wide reaching. In the fourth quarter of 2015, the authorities relaxed the exchange rate mechanism. They went from focusing on a tight band against the US dollar to adopting a broader band against a basket of currencies. While this was a positive step towards liberalising China’s foreign exchange markets, the poor communication about this change and its aim left many confused. I hope that these are just ‘teething problems’ for the authorities as China looks to liberalise its capital markets.
Reform in China will be key to the future success of the economy and markets. Despite the strong blueprint laid out in the third plenum, reform, particularly of state-owned enterprises (“SOEsâ€), has generally been slower than expected. However, we have seen some steps in the right direction, with improved management incentive schemes to align management and shareholder objectives, and an increase in public listing of assets and merger and acquisition (“M&Aâ€) activity among SOEs. Meanwhile, increased policy discussion about addressing “supply side†issues related to excess capacity in industrial sectors is clearly a positive, especially in areas such as steel. Execution, though, needs to be followed closely. Many companies in these industries have heavy debt levels, so the challenge of taking capacity out of these sectors and the non-performing loan problem at banks is closely related.
I spend a lot of time looking for SOEs that could benefit from such reform. I have found some interesting opportunities such as CITIC Telecom, which remains in a strong position to take on the CITIC Group’s significant broadband network in China, and Shanghai International Airport, where there is scope for further passenger growth and improved returns.
Despite this rather subdued message, what is often lost among the dramatic headlines is the long-term investment potential offered by China’s growing middle class and the associated multi-year growth in domestic demand. Indeed, consumption continues to expand at a robust pace and the economy is rebalancing towards a higher quality and more sustainable growth model. This has been reflected in the strength of the so-called “new economy†in areas such as online sales and travel.
Relative to the developed world, many consumer products and services in China remain vastly underpenetrated, which offer significant structural growth potential. In particular, rising internet and mobile usage is redefining the landscape, particularly in rural markets where traditional bricks and mortar enterprises have lagged. This provides a solid backdrop for further growth in consumption, internet penetration and e-commerce in China. The investment opportunities in these areas are reflected in the Company’s significant holdings in the consumer and information technology sectors.
Recently, we have also seen some improvement in areas that have been a drag on growth, such as property and trade. There has been improved pricing in some of the “old economy†industries such as steel. While the Company continues to focus primarily on “new economy†sectors, there are some opportunities to be found in more cyclical sectors, especially where we are seeing signs of supply adjustment combined with very low valuations.
Sell-offs in the market often tend to be broad-based and do not discriminate between the companies that are likely to benefit from structural trends and those that are clearly impacted by macro challenges. From an investment perspective, this provides a fertile environment for stock pickers to invest in attractively valued quality companies that are well-positioned to benefit from the ongoing development of China’s middle class. This is what the Company aims to do.
Performance Review
Despite the uncertain macro environment, the Company’s NAV remained flat over the year, driven mainly by stock selection in areas of the market that still offer excellent growth opportunities and attractive valuations. That said, the Company’s share price fell by 4.5% as sentiment reflected the general concerns highlighted above rather than the opportunities that I am seeing on the ground. However, this was a positive result relative to the China market as a whole, as represented by the 16.2% fall of the MSCI China Index. Overall, the Company’s focus on smaller and mid-cap companies was beneficial as much of the relative outperformance was from stocks with a market-capitalisation of below £5 billion. The Company benefited from the continued tilt towards consumer discretionary and technology companies. These companies operate in industries with structural growth drivers such as rising incomes, the expanding middle class and ongoing urbanisation.
Several positions in the consumer discretionary sector contributed to positive returns against the MSCI China Index. The position in budget hotel operator China Lodging rallied after it reported improved free cash flow in light of new franchised hotel openings and an increase in pre-paid membership. The exposure to New Oriental Education & Technology Group also proved rewarding as demand for its after-school tutorial services proved resilient. The company’s strong brand and emphasis on the quality of teachers supported an improvement in enrolment levels. Rising utilisation levels and the impact of heavy online investment is helping to drive margin improvement. Meanwhile, bakery chain Gourmet Master reported a recovery in its operating margins across geographies – China, Taiwan and US – while ongoing growth in its same store sales also bolstered sentiment towards the stock. Another consumption-led position in Zhejiang Supor Cookware continues to see strong results and is clearly benefiting from the strong technology support offered by its largest shareholder, France’s SEB, which continues to support a strong rollout of new products in the Chinese market.
Elsewhere, an overweight position in oncology and immunology focused drug innovator Hutchison China MediTech contributed to returns. Investors favoured the drug maker’s promising product pipeline and drug-specific partnerships with global healthcare leaders. The company has also now listed in the US which should support further understanding. Online games producer NetEase supported returns given the strong performance of its mobile games. Among industrial holdings, conviction in Shanghai International Airport’s prospects proved rewarding, given the solid growth in traffic and emergence as an international travel hub. The increase in its leasable area after the renovation of one of its key terminals also improved the prospects of its non-aeronautical business.
Conversely, China Animal Healthcare was the single largest detractor to relative performance over the year. The company manufactures and markets drugs and vaccines for poultry and other livestock, and there is a clear growth opportunity in this industry. However, during the year, its auditor resigned, accounting records were lost and its listing was suspended. Consequently its position was written down to zero. Elsewhere, CITIC Securities, which provides brokerage, trading and underwriting services suffered a volatile year in line with the market. While the position was reduced, the clampdown on margin finance and swings in market sentiment impacted trading volumes and consequently CITIC Securities’ revenue potential.
Positioning
Apart from gearing, the key change in the Company was the reduction in the exposure to A-shares in the middle of last year following a strong run. The overweight stance in the consumer sector was increased, while the exposure to healthcare was lowered. The underweight position in financials was also increased.
Within the consumer area, the Company took new positions in Dongfeng Motor, Fu Shou Yuan and Shangri-La. Shares in automobile company Dongfeng Motor, which has a joint venture with Peugeot and Nissan, were trading at historically low valuations and should benefit from a refresh of its product cycle. Funeral services firm Fu Shou Yuan has the potential to consolidate in a very fragmented and underdeveloped market. Meanwhile, international hotel chain Shangri-La was also trading at trough valuations. The company is nearing the peak of its recent capital expenditure programme and combined with stabilising fundamentals should see improved cash flows going forward. Overall, I remain a firm believer in the long-term structural consumption story in China. I continue to find some of the most attractive growth opportunities in this segment as many areas of consumption remain under-penetrated compared with other markets.
The Company has a sizeable overweight position in industrials, driven by the holding in Shanghai International Airport. It also owns smaller positions in Shenzhen Airport and Guangzhou Baiyun International Airport as both are located in tier one cities with strong potential for passenger growth and improved returns. Elsewhere, within industrials, the Company has strong market positions related to certain infrastructure spending, such as China State Construction International and Jiangnan Group. More cyclical stocks have been added, as well as selected names in deeper cyclical industries such as cement and paper due to an improvement in demand, supported by increased infrastructure spending, an improvement in the supply picture and low valuations. In the financial sector, I remain concerned about the growth of credit, particularly off balance sheet, and the potential implications this has for banks’ non-performing loan exposure. I continue to avoid banking stocks mostly for this reason. Conversely, I remain positive on the life insurance sector given low penetration rates, which are being reflected in strong new business growth, combined with valuations that reflect much lower growth rates. The Company has selected holdings in leasing companies that I believe have strong underwriting skills.
At the end of 2015, the Company bought its first unlisted position since the successful initial public offering of Alibaba in September 2014. Didi Chuxing manages both China’s and the world’s largest social transportation network. Through its online network and apps, users can hail taxis, private cars and arrange ride-sharing. There is a huge unmet demand in China for more efficient commuting and Didi Kuaizhi aims to position itself as a transportation solution provider. Both Alibaba and Tencent are strategic investors in the company. This position was initiated as part of a round of financing by the company in the third quarter of 2015, which valued the company at around US$16 billion. In a recent new round of financing, Didi’s valuation was increased to $20 billion, which has already been reflected in the Company’s NAV.
Company’s Gearing
The Company’s gearing detracted from returns as we were geared in a falling market. Although this was reduced as the market rose over the reporting period, it cost around 2% of performance. However, following the market correction and my view that the sell-off was overdone and that valuations were presenting real value, net gearing was increased closer to the upper limit of 30% in the first quarter of 2016. This was achieved through a combination of closing short stock positions (which added value in a falling market) and adding to existing holdings that had suffered due to broad-based sell-offs driven by broader negative sentiment rather than fundamentals. This level of gearing reflects my confidence that valuations in the Chinese market, particularly in areas like consumer, large-cap A-Shares and small-cap H-Shares, are attractive relative to their fundamentals and growth prospects.
Over the review period, the Company actively used gearing, reducing it when the market rallied as there was a greater risk of a market fall, and adding gearing when markets fell to low valuations, thereby creating more opportunities. This is a strategy that I will continue to pursue – capitalising on opportunities as I see them in the market.
The Company aims to provide shareholders with an exposure to China’s growth story to be held over the medium term. I am convinced that the Chinese middle class continues to grow both in wealth and in number and much of the Company is invested in businesses providing goods and services to the rising Chinese consumer market. However, I also look for undervalued opportunities whether in the SOE sector or in oversold parts of the market. Given the investment opportunities in China, I remain confident in our ability to grow the NAV of the Company over the medium-term.
Dale Nicholls
Portfolio Manager
1 June 2016
Fidelity International won the Money Observer’s Premier Investment Trust Group of the year.
Strategic Report
Principal Risks and Uncertainties and Risk Management
As required by provision C.2.1 of the 2014 UK Corporate Governance Code, the Board has a robust ongoing process for identifying, evaluating and managing the principal risks and uncertainties faced by the Company and this is reviewed on a regular basis.
The Board is responsible for the Company’s system of risk management and of internal controls and for reviewing its effectiveness. It determines the nature and extent of any risks it is willing to take in order to achieve its strategic objectives. An internal controls report providing an assessment of risks, together with controls to mitigate these risks, is prepared by the Managers and considered by the Audit Committee at each of its meetings.
The Alternative Investment Fund Manager, FIL Investment Services (UK) Limited also has responsibility for risk management for the Company. It works with the Board to identify and manage the principal risks and to ensure that the Board can continue to meet its UK corporate governance obligations.
The Board considers the following as the principal risks and uncertainties facing the Company:
Market risk
Investing in an emerging market such as the PRC subjects the Company to a higher level of market risk than investment in a more developed market. This is due, among other things, to the existence of greater market volatility, lower trading volumes, the risk of political and economic instability, legal and regulatory risks, risks relating to accounting practices, disclosure and settlement, a greater risk of market shut down, standards of corporate governance and more governmental limitations on foreign investment than are typically found in developed markets. This reporting year has seen considerable market volatility as outlined in the Chairman’s Statement and Portfolio Manager’s Review in the Annual Report. The Board reviews material economic, market and legislative changes at each Board meeting.
The Company has exposure to a number of companies with all or part of their business in Variable Interest Entity (“VIEâ€) structures. These are entities where there is a controlling interest that is not based on the majority of voting rights and may result in a risk to investors being unable to enforce their ownership rights in certain circumstances. The proportion of the portfolio invested in companies operating a VIE structure is monitored on a monthly basis by the Manager and holdings are reported to the Board.
Performance risk
The achievement of the Company’s performance objective relative to the market requires the taking of risk, such as strategy, asset allocation and stock selection, and may lead to underperformance of the Benchmark Index.
The Company has a clearly defined strategy and investment remit. There is a clearly defined Management Agreement, and borrowing/derivative limits are also set by the Board.
The portfolio is managed by a highly experienced Portfolio Manager. The Board relies on the Portfolio Manager’s skills and judgement to make investment decisions based on research and analysis of individual stocks and sectors. The Board reviews the performance of the portfolio against the Company’s Benchmark Index and that of its competitors and the outlook for the market with the Portfolio Manager at each Board meeting. The emphasis is on longterm investment performance and the Board accepts that by targeting long-term results the Company risks volatility in the shorter-term.
Performance improved and was well ahead of its Benchmark Index in the 2015/16 financial year as outlined in the Portfolio Manager’s Review above. The Company has also strongly outperformed its Benchmark Index since launch.
Discount control risk
Due to the nature of investment companies, the Board cannot control the discount at which the Company’s share price trades to Net Asset Value. However, it can influence this through its share repurchase policy and through creating demand for shares through good performance and an active investor relations programme. The Company’s share price, NAV and discount volatility are monitored daily by the Managers and regularly reported to the Board. Further details are provided in the Chairman’s Statement.
Gearing risk
The Company has the option to invest up to the total of any loan facilities and to use Contracts For Difference (“CFDsâ€) to invest in equities. The principal risk is that while in a rising market the Company should benefit from gearing, in a falling market the impact would be detrimental. Other risks are that the cost of gearing may be too high or that the term of the gearing inappropriate in relation to market conditions. The Company has a US$150,000,000 revolving credit facility agreement with Scotiabank Europe PLC which has been fully drawn down. Additional geared exposure is being achieved through the use of long CFDs. The Board regularly considers gearing and gearing risk.
Currency risk
The functional currency and presentational currency of the Company in which it reports its results, is UK sterling. Most of its assets and its income are denominated in other currencies, mainly Hong Kong dollars, US dollars and Chinese renminbi. Consequently, it is subject to currency risk on exchange rate movements between UK sterling and these other currencies. It is the Company’s current policy not to hedge against currency risks. Borrowings are denominated in US dollars and, therefore, the effect of US dollar exchange rate movements on assets denominated in US dollars will be offset by the effect on these loans. Further details can be found in Note 18 to the Financial Statements in the Annual Report.
Other risks facing the Company include:
Tax and Regulatory risks
A breach of Section 1158 of the Corporation Tax Act 2010 could lead to a loss of investment trust status, resulting in the Company being subject to tax on capital gains. The Board receives regular reports from the Managers confirming tax and regulatory compliance during the year.
The Board monitors tax and regulatory changes at each Board meeting and is provided with regular briefings from the Association of Investment Companies (“AICâ€) as well as details of industry and the Managers lobbying activities.
Operational risks – Service Providers
The Company relies on a number of third party service providers, principally the Managers, Registrar, Custodian and Depositary. It is dependent on the effective operation of the Managers’ control systems and those of its service providers with regard to the security of the Company’s assets, dealing procedures, accounting records and the maintenance of regulatory and legal
requirements.
They are all subject to a risk-based programme of internal audits by the Manager. In addition, service providers’ own internal controls reports are received by the Board on an annual basis an any concerns investigated.
Viability Statement
In accordance with provision C.2.2 of the UK Corporate Governance Code, issued by the Financial Reporting Council in September 2014, the Directors have assessed the prospects of the Company over a longer period than the twelve month period required by the “Going Concern†provision. The Company is an investment trust with the objective of achieving long term capital growth and the Board consider five years is an appropriate investment horizon to assess the viability of the Company, although the life of the Company is not intended to be limited to this or any other period.
In making an assessment on the viability of the Company, the Board has considered the following:
· The ongoing relevance of the investment objective in prevailing market conditions;
· The principal risks and uncertainties facing the Company as set out above and their potential impact;
· The demand for the Company’s shares;
· The Company’s discount to the NAV;
· The liquidity of the Company’s portfolio;
· The level of income generated by the Company; and
· Future income and expenditure forecasts
The Company’s performance has been strong since launch and the investment policy is kept under review and the Board considers it to be appropriate. Based on the Managers’ compliance with the Company’s investment objective, its investment strategy and asset allocation and the fact that the portfolio mainly comprises readily realisable securities which can be sold to meet funding requirements if necessary; the Board’s discount management policy; and the ongoing processes for monitoring operating costs and income forecasts, the Board have concluded that there is a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the next five years.
In addition, the Directors’ assessment of the Company’s ability to operate in the foreseeable future is included in the Going Concern statement in the Annual Report.
Going Concern
The Directors have considered the Company’s investment objective, risk management policies, liquidity risk, credit risk, capital management policies and procedures, the nature of its portfolio (being mainly securities which are readily realisable) and its expenditure and cash flow projections and have concluded that the Company has adequate resources to continue to adopt a going concern basis for at least 12 months from the date of this Annual report in preparing these Financial Statements.
Statement of Directors’ Responsibilities
The Directors are responsible for preparing the Annual Report and the Financial Statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial period. Under that law they have elected to prepare the Financial Statements in accordance with International Financial Reporting Standards (“IFRSâ€) as adopted by the European Union.
The Financial Statements are required by law to give a true and fair view of the state of affairs of the Company and of the loss for the period.
In preparing these Financial Statements the Directors are required to:
· select suitable accounting policies and then apply them consistently;
· make judgements and estimates that are reasonable and prudent;
· state whether applicable IFRS have been followed, subject to any material departures disclosed and explained in the Financial Statements;
· prepare the Financial Statements on the going concern basis unless it is inappropriate to assume that the Company will continue in business; and
· confirm that the Financial Statements are fair, balanced and understandable.
The Directors are responsible for ensuring that adequate accounting records are kept which disclose with reasonable accuracy at any time the financial position of the Company and to enable them to ensure that the Financial Statements comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
Under applicable law and regulations the Directors are also responsible for preparing a Strategic Report, a Directors’ Report, a Corporate Governance Statement and a Directors’ Remuneration Report that comply with that law and those regulations.
The Directors have delegated responsibility for the maintenance and integrity of the corporate and financial information included on the Company’s pages of the Manager’s website at www. fidelityinvestmenttrusts.com to the Managers. Visitors to the website need to be aware that legislation in the UK governing the preparation and dissemination of the Financial Statements may differ from legislation in their jurisdictions.
We confirm that to the best of our knowledge the Financial Statements, prepared in accordance with International Financial Reporting Standards as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position and loss of the Company; and the Strategic Report and Directors’ Report include a fair review of the development and performance of the business and the position of the Company together with a description of the principal risks and uncertainties it faces. We confirm that we consider the Annual Report and Financial Statements, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s performance, business model and strategy.
Approved by the Board on 1 June 2016 and signed on its behalf.
John Owen
Chairman
Income Statement
for the year ended 31 March 2016
| Year ended 31 March 2016 | Year ended 31 March 2015 | |||||||||||||
| revenue | capital | total | revenue | capital | total | |||||||||
| Notes | £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | ||||||||
| Revenue | ||||||||||||||
| Investment income | 3 | 17,571 | – | 17,571 | 14,613 | – | 14,613 | |||||||
| Derivative income | 3 | 2,345 | – | 2,345 | 796 | – | 796 | |||||||
| Other income | 3 | 118 | – | 118 | 29 | – | 29 | |||||||
| Total income | 20,034 | – | 20,034 | 15,438 | – | 15,438 | ||||||||
| (Losses)/gains on investments held at fair value through profit or loss | 10 | – | (5,445 | ) | (5,445 | ) | – | 273,943 | 273,943 | |||||
| Gains on derivative instruments | 11 | – | 6,832 | 6,832 | – | 32,136 | 32,136 | |||||||
| Foreign exchange (losses)/gains on other net assets | (42 | ) | 3,281 | 3,239 | 14 | 2,102 | 2,116 | |||||||
| Foreign exchange losses on bank loans | – | (3,301 | ) | (3,301 | ) | – | (11,051 | ) | (11,051 | ) | ||||
| Total income and gains | 19,992 | 1,367 | 21,359 | 15,452 | 297,130 | 312,582 | ||||||||
| Expenses | ||||||||||||||
| Investment management and performance fees | 4 | (4,569 | ) | (13,707 | ) | (18,276 | ) | (4,047 | ) | (8,791 | ) | (12,838 | ) | |
| Other expenses | 5 | (1,911 | ) | – | (1,911 | ) | (1,763 | ) | – | (1,763 | ) | |||
| Profit/(loss) before finance costs and taxation | 13,512 | (12,340 | ) | 1,172 | 9,642 | 288,339 | 297,981 | |||||||
| Finance costs | 6 | (1,499 | ) | (1,499 | ) | (2,998 | ) | (1,064 | ) | (1,064 | ) | (2,128 | ) | |
| Profit/(loss) before taxation | 12,013 | (13,839 | ) | (1,826 | ) | 8,578 | 287,275 | 295,853 | ||||||
| Taxation | 7 | (413 | ) | 1,300 | 887 | (515 | ) | (663 | ) | (1,178 | ) | |||
| Net profit/(loss) after taxation for the year | 11,600 | (12,539 | ) | (939 | ) | 8,063 | 286,612 | 294,675 | ||||||
| Earnings/(loss) per Ordinary Share | 8 | 2.07p | (2.24p | ) | (0.17p | ) | 1.41p | 50.17p | 51.58p | |||||
The Company does not have any income or expenses that are not included in the net profit/(loss) for the year. Accordingly the net profit/(loss) after taxation for the year is also the total comprehensive income for the year 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 AIC.
All of the profit and total comprehensive income is attributable to the equity shareholders of the Company. There are no minority interests.
No operations were acquired or discontinued in the year and all items in the above statement derive from continuing operations.
The Notes form an integral part of these Financial Statements.
Statement of Changes in Equity
for the year ended 31 March 2016
| share | capital | |||||||||||||||
| share | premium | redemption | other | capital | revenue | total | ||||||||||
| capital | account | reserve | reserve | reserve | reserve | equity | ||||||||||
| Notes | £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |||||||||
| Total equity at 31 March 2015 | 5,713 | 211,569 | 914 | 366,249 | 346,743 | 12,947 | 944,135 | |||||||||
| Repurchase of Ordinary Shares | 15 | – | – | – | (27,412 | ) | – | – | (27,412 | ) | ||||||
| Net (loss)/profit after taxation for the year | – | – | – | – | (12,539 | ) | 11,600 | (939 | ) | |||||||
| Dividend paid | 9 | – | – | – | – | – | (7,306 | ) | (7,306 | ) | ||||||
| Total equity at 31 March 2016 | 5,713 | 211,569 | 914 | 338,837 | 334,204 | 17,241 | 908,478 | |||||||||
| Total equity at 31 March 2014 | 5,713 | 211,569 | 914 | 366,370 | 60,131 | 11,455 | 656,152 | |||||||||
| Repurchase of Ordinary Shares | 15 | – | – | – | (121 | ) | – | – | (121 | ) | ||||||
| Net profit after taxation for the year | – | – | – | – | 286,612 | 8,063 | 294,675 | |||||||||
| Dividend paid | 9 | – | – | – | – | – | (6,571 | ) | (6,571 | ) | ||||||
| Total equity at 31 March 2015 | 5,713 | 211,569 | 914 | 366,249 | 346,743 | 12,947 | 944,135 |
The Notes form an integral part of these Financial Statements.
Balance Sheet
as at 31 March 2016
Company number 7133583
| 2016 | 2015 | |||||
| Notes | £’000 | £’000 | ||||
| Non current assets | ||||||
| Investments held at fair value through profit or loss | 10 | 987,878 | 1,001,043 | |||
| Current assets | ||||||
| Derivative instruments | 11 | 20,275 | 43,907 | |||
| Amounts held at futures clearing houses and brokers | 12,740 | 1,383 | ||||
| Other receivables | 12 | 3,531 | 3,388 | |||
| Cash and cash equivalents | 30,266 | 14,932 | ||||
| 66,812 | 63,610 | |||||
| Current liabilities | ||||||
| Derivative instruments | 11 | (28,082 | ) | (2,134 | ) | |
| Bank loans | 13 | (104,315 | ) | (101,014 | ) | |
| Overseas capital gains tax payable | – | (1,300 | ) | |||
| Other payables | 14 | (13,815 | ) | (16,070 | ) | |
| (146,212 | ) | (120,518 | ) | |||
| Net current liabilities | (79,400 | ) | (56,908 | ) | ||
| Net assets | 908,478 | 944,135 | ||||
| Equity attributable to equity shareholders | ||||||
| Share capital | 15 | 5,713 | 5,713 | |||
| Share premium account | 16 | 211,569 | 211,569 | |||
| Capital redemption reserve | 16 | 914 | 914 | |||
| Other reserve | 16 | 338,837 | 366,249 | |||
| Capital reserve | 16 | 334,204 | 346,743 | |||
| Revenue reserve | 16 | 17,241 | 12,947 | |||
| Total equity | 908,478 | 944,135 | ||||
| Net asset value per Ordinary Share | 17 | 164.18p | 165.27p |
The Financial Statements were approved by the Board of Directors and authorised for issue on 1 June 2016 and were signed on its behalf by:
John Owen
Chairman
The Notes form an integral part of these Financial Statements.
Cash Flow Statement
for the year ended 31 March 2016
| 2016 | 2015 | |||
| £’000 | £’000 | |||
| Operating activities | ||||
| Cash inflow from investment income | 17,375 | 13,466 | ||
| Cash inflow from derivative income | 2,345 | 796 | ||
| Cash inflow from other income | 118 | 29 | ||
| Cash outflow from Directors’ fees | (164 | ) | (155 | ) |
| Cash outflow from other payments | (15,757 | ) | (15,620 | ) |
| Cash outflow from the purchase of investments | (628,799 | ) | (565,796 | ) |
| Cash outflow from the purchase of derivatives | (9,340 | ) | (3,261 | ) |
| Cash inflow from the sale of investments | 628,999 | 579,499 | ||
| Cash inflow/(outflow) from the settlement of derivatives | 65,752 | (1,630 | ) | |
| Cash outflow from amounts held at futures clearing houses and brokers | (11,357 | ) | (1,383 | ) |
| Net cash inflow from operating activities | 49,172 | 5,945 | ||
| Financing activities | ||||
| Cash outflow from loan interest paid | (1,533 | ) | (1,376 | ) |
| Cash outflow from CFD interest paid | (992 | ) | (546 | ) |
| Cash outflow short CFD dividends paid | (384 | ) | (178 | ) |
| Cash outflow from the repurchase of Ordinary Shares | (26,904 | ) | (1,106 | ) |
| Cash outflow from dividends paid to shareholders | (7,306 | ) | (6,571 | ) |
| Cash outflow from financing activities | (37,119 | ) | (9,777 | ) |
| Increase/(decrease) in cash and cash equivalents | 12,053 | (3,832 | ) | |
| Cash and cash equivalents at the start of the year | 14,932 | 16,662 | ||
| Effect of foreign exchange movements | 3,281 | 2,102 | ||
| Cash and cash equivalents at the end of the year | 30,266 | 14,932 |
The Notes form an integral part of these Financial Statements.
Notes to the Financial Statements
1 Principal Activity
Fidelity China Special Situations PLC is an Investment Company incorporated in England and Wales with a premium listing on the London Stock Exchange. The Company’s registration number is 7133583, and its registered office is Beech Gate, Millfield Lane, Lower Kingswood, Tadworth, Surrey, KT20 6RP. The Company has been approved by HM Revenue & Customs as an Investment Trust under Section 1158 of the Corporation Tax Act, 2010 and intends to conduct its affairs so as to continue to be approved.
2 Accounting Policies
The Company’s Financial Statements have been prepared in accordance with International Financial Reporting Standards (“IFRSâ€), to the extent that they have been adopted by the European Union, the Companies Acts that apply to companies reporting under IFRS, IFRC interpretations and, as far as it is consistent with IFRS, with the Statement of Recommended Practice: Financial Statements of Investment Trust Companies and Venture Capital Trusts (“SORPâ€) issued by the Association of Investment Companies (“AICâ€), in November 2014. The accounting policies adopted in the preparation of these financial statements are summarised below.
a) Basis of accounting – The Financial Statements have been prepared on a going concern basis and under the historical cost convention, except for the measurement at fair value of investments and derivative assets and liabilities.
b) Adoption of new and revised Financial Reporting Standards – The accounting policies adopted are consistent with those of the previous financial year.
At the date of authorisation of these Financial Statements, the following Standards and Interpretations were in issue but not yet effective:
· IFRS 9: Financial Instruments
· IFRS 15: Revenue from Contracts with Customers
· IFRS 16: Leases
It is anticipated that the adoption of these Standards and Interpretations in future periods will have no material financial effect on the financial statements of the Company.
c) Segmental reporting – The Company is engaged in a single segment business and, therefore, no segmental reporting is provided.
d) Presentation of the Income Statement – In order to reflect better the activities of an investment company and in accordance with guidance issued by the AIC, supplementary information which analyses the Income Statement between items of a revenue and capital nature has been prepared alongside the Income Statement. The net revenue profit after taxation is the measure the Directors believe appropriate in assessing the Company’s compliance with certain requirements set out in Section 1159 of the Corporation Tax Act 2010.
e) Significant accounting estimates and judgements – The Directors make judgements and estimates concerning the future. Estimates and judgements are continually evaluated and are based on historical experience and other factors, such as expectations of future events, and are believed to be reasonable under the circumstances. Actual results may differ from these estimates. The judgements required in order to determine the appropriate valuation methodology of unquoted equity investments have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities. These judgements include making assessments of the possible valuations in the event of a listing and other marketability related risks.
f) Income – Income from equity investments and derivative instruments is credited to the revenue column of the Income Statement on the date on which the right to receive the payment is established, normally the ex dividend date. Where the Company has elected to receive its dividends in the form of additional shares rather than cash, the amount of the cash dividend foregone is recognised as income. Any excess in the value of the shares received over the amount of the cash dividend foregone is recognised as a gain in the capital column of the Income Statement. Special dividends are treated as a revenue receipt or a capital receipt depending on the facts and circumstances of each particular case. Interest income is accounted for on an accruals basis.
g) Foreign currency – The Directors, having regard to the Company’s share capital and the predominant currency in which its investors operate, have determined the functional currency to be UK sterling. Transactions denominated in foreign currencies are calculated in UK sterling at the rate of exchange ruling at the date of the transactions. Assets and liabilities in foreign currencies are translated at the rates of exchange ruling at the Balance Sheet date. All capital gains and losses, including exchange differences on the translation of foreign currency assets and liabilities, are dealt with in capital reserve.
h) Expenses – Expenses are accounted for on an accruals basis and are charged as follows:
· Any performance fee, if due, is allocated entirely to capital, as the Board believe it reflects the capital performance of the Company’s investments;
· The investment management fee is allocated equally between revenue and capital; and
· All other expenses are allocated in full to revenue with the exception of those directly attributable to share issues or other capital events.
i) Finance costs – Finance costs comprise interest and fees on bank loans and overdrafts and interest paid on CFDs, which are accounted for on an accruals basis using the effective interest method, and dividends paid on short CFDs, which are accounted for on the date on which the obligation to incur the cost is established, normally the ex-dividend date. Finance costs are allocated equally between revenue and capital.
j) Taxation – The taxation expense/(credit) represents the sum of current taxation and deferred taxation.
Taxation currently payable is based on the taxable profit for the year. Taxable profit differs from profit before taxation, as reported in the Income Statement, because it excludes items of income or expense that are taxable or deductible in other years and items that are never taxable or deductible. The Company’s liability for current taxation is calculated using taxation rates that have been enacted or substantially enacted by the Balance Sheet date.
Deferred taxation is the taxation expected to be payable or recoverable on differences between the carrying amounts of assets and liabilities in the Financial Statements and the corresponding taxation bases used in the computation of taxable profit based on tax rates that have been enacted or substantively enacted when the taxation is expected to be payable or recoverable, and is accounted for using the balance sheet liability method. Deferred taxation liabilities are recognised for all taxable temporary differences and deferred taxation assets are recognised to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilised.
Taxation is charged or credited to the revenue column of the Income Statement, except where it relates to items of a capital nature, in which case it is charged or credited to the capital column of the Income Statement. Where expenses are allocated between revenue and capital any tax relief in respect of the expenses is allocated between revenue and capital returns on the marginal basis using the Company’s effective rate of corporation tax for the accounting period. The Company is an approved Investment Trust under Section 1158 of the Corporation Tax Act 2010 and is not liable for UK taxation on capital gains.
k) Dividends paid – Dividends payable to equity shareholders are recognised when the Company’s obligation to make payment is established.
l) Investment held at fair value through profit or loss – The portfolio of financial assets is managed and its performance evaluated on a fair value basis, in accordance with a documented investment strategy, and information about the portfolio is provided on that basis to the Company’s Board of Directors. Investments are designated by the Company as held at fair value through profit or loss, which is initially taken to be their cost, and is subsequently measured as bid or last traded prices, depending upon the convention of the exchange on which they are listed, where available, or otherwise at fair value based on published price quotations. Investments which are not quoted, or are not frequently traded, are stated at the Directors best estimate of fair value. The Manager’s Fair Value Committee, which is independent of the Portfolio Manager’s team, provides a recommendation of fair values to the Directors based on recognised valuation techniques that take account of recent arms length transactions in the same or similar investments.
In accordance with the AIC SORP, the Company includes transaction costs, incidental to the purchase or sale of investments within gains on investments held at fair value through profit or loss in the capital column of the Income Statement and has disclosed them in note 10 below.
m) Derivative instruments held at fair value through profit or loss – When appropriate, permitted transactions in derivative instruments are used. Derivative transactions into which the Company may enter include CFDs, futures, options, warrants and forward currency contracts. Derivatives are classified as fair value through profit or loss – held for trading, and are initially accounted and measured at fair value on the date the derivative contract is entered into and subsequently measured at fair value as follows:
· CFDs – the difference between the strike price and the value of the underlying shares in the contract, calculated in accordance with accounting policy 2(l) above; and
· Futures and options – the quoted trade price for the contract.
Where such transactions are used to protect or enhance income, if the circumstances support this, then the income derived is included in derivative income in the revenue column of the Income Statement. Where such transactions are used to protect or enhance capital, if the circumstances support this, the gains and losses derived are included in gains on derivative instruments held at fair value through profit or loss in the capital column of the Income Statement. Any positions on such transactions open at the year end are reflected in the Balance Sheet at their fair value within current assets or current liabilities.
The Company obtains equivalent exposure to Chinese and Hong Kong equities through the use of CFDs. All gains and losses in the fair value of the CFDs are included in gains on derivative instruments held at fair value through profit or loss in the capital column of the Income Statement.
n) Amounts held at futures clearing houses and brokers – Amounts held at futures clearing houses and brokers are readily convertible to a known amount of cash and are subject to an insignificant risk of changes in value.
o) Other receivables – Other receivables include securities sold for future settlement, accrued income and other debtors and pre-payments incurred in the ordinary course of business. If collection is expected in one year or less (or in the normal operating cycle of the business, if longer) they are classified as current assets. If not, they are presented as non-current assets. Debtors are recognised initially at fair value and, where applicable, subsequently measured at amortised cost using the effective interest rate method.
p) Cash and cash equivalents – Cash and cash equivalents may comprise cash and short-term money market funds which are readily convertible to a known amount of cash and are subject to an insignificant risk of changes in value.
q) Bank loans – Loans are initially included in the financial statements at cost, being the fair value of the consideration received net of any issue costs relating to the borrowing. After initial recognition, the loans are measured at amortised cost using the effective interest rate method. The amortised cost is calculated by taking into account any issue costs and any discount or premium on settlement.
r) Other payables – Other payables include securities purchased for future settlement, amounts payable on share repurchases, performance fees payable, investment management and secretarial fees payable, interest payable and other creditors and expenses accrued in the ordinary course of business. Other payables are classified as current liabilities if payment is due within one year or less (or in the normal operating cycle of the business, if longer). If not, they are presented as non-current liabilities. Other payables are recognised initially at fair value and, where applicable, subsequently measured at amortised cost using the effective interest rate method.
s) Share premium account and other reserve – The full cost of shares repurchased and held in treasury is charged to other reserve. Where treasury shares are subsequently reissued, any surplus is taken to the share premium account.
t) Capital reserve – The following are transferred to capital reserve:
· Gains and losses on the disposal of investments and derivatives instruments;
· Changes in the fair value of investments and derivative instruments, held at the year end;
· Foreign exchange gains and losses of a capital nature;
· Performance fees;
· 50% of investment management fees;
· 50% of finance costs;
· Dividends receivable which are capital in nature; and
· Taxation charged or credited relating to items which are capital in nature.
As a result of technical guidance by the Institute of Chartered Accountants in England and Wales in TECH 02/10: Guidance on the determination of realised profits and losses in the context of distributions under the Companies Act 2006, changes in the fair value of investments which are readily convertible to cash, without accepting adverse terms at the Balance Sheet date, can be treated as realised. Capital reserves realised and unrealised are shown in aggregate as capital reserve in the Statement of Changes in Equity and the Balance Sheet. At the Balance Sheet date all investments held by the Company were listed on a recognised stock exchange and were considered to be readily convertible to cash, with the exception of level 3 investments with a fair value of £20,317,000 (2015: £160,000).
3 Income
| Year ended | Year ended | |||
| 31.03.16 | 31.03.15 | |||
| £’000 | £’000 | |||
| Investment income | ||||
| Overseas dividends | 17,546 | 14,548 | ||
| Overseas scrip dividends | 25 | 65 | ||
| 17,571 | 14,613 | |||
| Derivative income | ||||
| Dividends on long CFDs | 2,340 | 796 | ||
| Interest on short CFDs | 5 | – | ||
| 2,345 | 796 | |||
| Other income | ||||
| Deposit interest | 118 | 29 | ||
| Total income | 20,034 | 15,438 |
4 Investment Management and Performance Fees
| Year ended 31 March 2016 | Year ended 31 March 2015 | |||||||||||
| revenue | capital | total | revenue | capital | total | |||||||
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |||||||
| Investment management fee | 4,569 | 4,569 | 9,138 | 4,047 | 4,047 | 8,094 | ||||||
| Performance fee | – | 9,138 | 9,138 | – | 4,744 | 4,744 | ||||||
| 4,569 | 13,707 | 18,276 | 4,047 | 8,791 | 12,838 | |||||||
FIL Investment Services (UK) Limited (a Fidelity group company) is the Company’s Alternative Investment Fund Manager (“the Managerâ€) and has delegated portfolio management to FIL Investment Management (Hong Kong) Limited and FIL Investments International (“the Investment Managersâ€). The Investment Managers provided investment management services for an annual fee of 1.0% of the net asset value (“NAVâ€). Fees are payable quarterly in arrears and are calculated on the last business day of March, June, September and December.
In addition, the Investment Managers are entitled to an annual performance fee of 15.0% of any change in the NAV per Ordinary Share attributable to performance which is more than 2% above the return on the MSCI China Index, subject to a maximum performance fee payable in any year equal to 1.0% of the arithmetic mean of the NAV calculated at the end of each month during the year. The performance fee payable this year is capped at 1% (2015: the fee was below the cap). Any out-performance above the cap is lost. If the Company’s NAV performance in any year is less than 2% above the return on the MSCI China Index, the under-performance must be made good before any further performance fee becomes payable. Both the NAV per Ordinary Share and the MSCI China Index are calculated on a total return basis.
5 Other Expenses
| Year ended | Year ended | |||
| 31.03.16 | 31.03.15 | |||
| £’000 | £’000 | |||
| AIC fees | 20 | 21 | ||
| Custody fees | 420 | 351 | ||
| Depositary fees | 62 | 51 | ||
| Directors’ expenses | 62 | 54 | ||
| Directors’ fees1 | 164 | 156 | ||
| Legal and professional fees | 76 | 92 | ||
| Marketing expenses | 230 | 174 | ||
| Printing and publication expenses | 122 | 114 | ||
| Registrars’ fees | 72 | 73 | ||
| Secretarial and administration fees payable to the Investment Managers | 600 | 600 | ||
| Other expenses | 55 | 47 | ||
| Fees payable to the Independent Auditor for the audit of the Financial Statements | 28 | 30 | ||
| 1,911 | 1,763 |
1 Details of the breakdown of Directors’ fees are provided within the Directors’ Remuneration Report in the Annual Report.
6 Finance Costs
| Year ended 31 March 2016 | Year ended 31 March 2015 | |||||||||||
| revenue | capital | total | revenue | capital | total | |||||||
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |||||||
| Interest on bank loans and overdrafts | 794 | 794 | 1,588 | 693 | 693 | 1,386 | ||||||
| Interest paid on CFDs | 513 | 513 | 1,026 | 282 | 282 | 564 | ||||||
| Dividends paid on short CFDs | 192 | 192 | 384 | 89 | 89 | 178 | ||||||
| 1,499 | 1,499 | 2,998 | 1,064 | 1,064 | 2,128 | |||||||
7 Taxation
| Year ended 31 March 2016 | Year ended 31 March 2015 | |||||||||||
| revenue | capital | total | revenue | capital | total | |||||||
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |||||||
| a) Analysis of the taxation (credit)/charge for the year | ||||||||||||
| Overseas taxation charge | 413 | – | 413 | 515 | – | 515 | ||||||
| Overseas capital gains tax (credit)/charge1 | – | (1,300 | ) | (1,300 | ) | – | 663 | 663 | ||||
| Total taxation (credit)/charge for the year (see Note 7b) | 413 | (1,300 | ) | (887 | ) | 515 | 663 | 1,178 | ||||
1 The Chinese capital gains tax provision has been released following the ratification of a new tax treaty between the UK and China.
b) Factors affecting the taxation (credit)/charge for the year
The taxation (credit)/charge for the year is higher/lower than the standard rate of UK corporation tax for an investment trust company of 20% (2015: 21%). A reconciliation of the standard rate of UK corporation tax to the taxation (credit)/charge for the year is shown below:
| Year ended 31 March 2016 | Year ended 31 March 2015 | |||||||||||
| revenue | capital | total | revenue | capital | total | |||||||
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |||||||
| Profit/(loss) before taxation | 12,013 | (13,839 | ) | (1,826 | ) | 8,578 | 287,275 | 295,853 | ||||
| Profit/(loss) before taxation multiplied by the standard rate of UK corporation tax of 20% (2015: 21%) | 2,403 | (2,768 | ) | (365 | ) | 1,801 | 60,328 | 62,129 | ||||
| Effects of: | ||||||||||||
| Gains on investments not taxable2 | – | (150 | ) | (150 | ) | – | (62,397 | ) | (62,397 | ) | ||
| Income not taxable | (3,374 | ) | – | (3,374 | ) | (2,999 | ) | – | (2,999 | ) | ||
| Excess expenses | 971 | 2,918 | 3,889 | 1,204 | 2,069 | 3,273 | ||||||
| Overseas taxation expensed | – | – | – | (6 | ) | – | (6 | ) | ||||
| Overseas taxation | 413 | – | 413 | 515 | – | 515 | ||||||
| Overseas capital gains tax | – | (1,300 | ) | (1,300 | ) | – | 663 | 663 | ||||
| Total taxation (credit)/charge (Note 7a) | 413 | (1,300 | ) | (887 | ) | 515 | 663 | 1,178 | ||||
2 The Company is exempt from UK taxation on capital gains as it meets the HM Revenue & Customs criteria for an investment company set out in Section 1159 of the Corporation Tax Act 2010.
c) Deferred taxation
A deferred tax asset of £14,870,000 (2015: £12,475,000), in respect of excess management expenses of £78,771,000 (2015: £59,328,000) and excess loan interest of £3,842,000 (2015: £3,049,000), has not been recognised as it is unlikely that there will be sufficient future taxable profits to utilise these expenses.
8 Earnings/(loss) per Ordinary Share
| Year ended 31 March 2016 | Year ended 31 March 2015 | |||||||||||
| revenue | capital | total | revenue | capital | total | |||||||
| Earnings/(loss) per Ordinary Share – basic and diluted | 2.07p | (2.24p | ) | (0.17p | ) | 1.41p | 50.17p | 51.58p | ||||
Earnings/(loss) per Ordinary Share is based on the revenue net profit after taxation for the year of £11,600,000 (2015: £8,063,000), the capital net loss after taxation for the year of £12,539,000 (2015: net profit £286,612,000) and the total net loss after taxation for the year of £939,000 (2015: net profit £294,675,000) and on 559,532,936 (2015: 571,313,658) Ordinary Shares, being the weighted average number of Ordinary Shares held outside Treasury in issue during the year. Basic and diluted earnings per share are the same as the Company has no dilutive financial instruments.
9 Dividends paid
| Year ended | Year ended | |||
| 31.03.16 | 31.03.15 | |||
| £’000 | £’000 | |||
| Dividend paid | ||||
| Dividend paid of 1.30 pence per Ordinary Share for the year ended 31 March 2015 | 7,306 | – | ||
| Dividend paid of 1.15 pence per Ordinary Share for the year ended 31 March 2014 | – | 6,571 | ||
| 7,306 | 6,571 | |||
| Dividend proposed | ||||
| Dividend proposed of 1.80 pence per Ordinary Share for the year ended 31 March 2016 | 9,950 | – | ||
| Dividend proposed of 1.30 pence per Ordinary Share for the year ended 31 March 2015 | – | 7,332 | ||
| 9,950 | 7,332 |
The Directors have proposed the payment of a dividend for the year ended 31 March 2016 of 1.80 pence per Ordinary Share which is subject to approval by shareholders at the Annual General Meeting and has not been included as a liability in these financial statements. The dividend will be paid on 26 July 2016 to shareholders on the register at the close of business on 24 June 2016 (ex dividend date 23 June 2016).
10 Investments held at fair value through profit or loss
| 2016 | 2015 | |||
| £’000 | £’000 | |||
| Total investments* | 987,878 | 1,001,043 | ||
| Opening book cost | 817,499 | 656,421 | ||
| Opening investment holding gains | 183,544 | 78,898 | ||
| Opening fair value and gross asset exposure of investments | 1,001,043 | 735,319 | ||
| Movements in the year | ||||
| Purchases at cost | 621,679 | 573,916 | ||
| Sales – proceeds | (629,399 | ) | (582,135 | ) |
| Sales – gains in the year | 134,318 | 169,297 | ||
| Movement in investment holding (losses)/gains in the year | (139,763 | ) | 104,646 | |
| Closing fair value and gross asset exposure of investments | 987,878 | 1,001,043 | ||
| Closing book cost | 944,097 | 817,499 | ||
| Closing investment holding gains | 43,781 | 183,544 | ||
| Closing fair value and gross asset exposure of investments | 987,878 | 1,001,043 |
* The fair value hierarchy of the investments is shown in Note 18 below.
| Year ended | Year ended | |||
| 31.03.16 | 31.03.15 | |||
| £’000 | £’000 | |||
| (Losses)/gains on investments | ||||
| Gains on sales of investments | 134,318 | 169,297 | ||
| Investment holding (losses)/gains | (139,763 | ) | 104,646 | |
| (5,445 | ) | 273,943 |
Investment transaction costs
Transaction costs incurred in the acquisition and disposal of investments, which are included in the (losses)/gains on investments held at fair value through profit or loss in the capital column of the Income Statement, were as follows:
| Year ended | Year ended | |||
| 31.03.16 | 31.03.15 | |||
| £’000 | £’000 | |||
| Purchases transaction costs | 1,429 | 1,375 | ||
| Sales transaction costs | 1,254 | 1,169 | ||
| 2,683 | 2,544 |
The portfolio turnover rate for the year was 63.9% (2015: 68.3%).
Substantial interest
As at 31 March 2016 the Company held 8,435,776 ordinary shares of 10 pence each in DJI Holdings PLC, a company listed on AIM and incorporated in the UK. This holding represented 5.8% of the issued share capital of DJI Holdings PLC which, in the opinion of the Directors, did not represent a participating interest.
11 Derivative instruments
| Year ended | Year ended | |||
| 31.03.16 | 31.03.15 | |||
| Net gains on derivative instruments | £’000 | £’000 | ||
| Realised gains/(losses) on CFDs | 34,593 | (3,155 | ) | |
| Realised gains on futures | 12,865 | – | ||
| Realised gains/(losses) on options | 7,688 | (2,005 | ) | |
| Realised losses on warrants | (2 | ) | – | |
| Movement on investment holding (losses)/gains on CFDs | (47,305 | ) | 36,703 | |
| Movement on investment holding losses on futures | (514 | ) | – | |
| Movement on investment holding (losses)/gains on options | (355 | ) | 874 | |
| Movement on investment holding losses on warrants | (138 | ) | (281 | ) |
| 6,832 | 32,136 | |||
| 2016 | 2015 | |||
| fair value | fair value | |||
| Fair value of derivative instruments recognized on the Balance Sheet | £’000 | £’000 | ||
| Derivative assets held at fair value through profit or loss | 20,275 | 43,907 | ||
| Derivative liabilities held at fair value through profit or loss | (28,082 | ) | (2,134 | ) |
| (7,807 | ) | 41,773 |
| 2016 | 2015 | |||||||
| gross asset | gross asset | |||||||
| fair value | exposure | fair value | exposure | |||||
| At the year end the Company held the following derivative instruments | £’000 | £’000 | £’000 | £’000 | ||||
| Long CFDs | (5,583 | ) | 204,668 | 40,691 | 137,324 | |||
| Short CFDs | – | – | (679 | ) | 22,757 | |||
| Short CFD (hedging exposure) | (1,710 | ) | (16,818 | ) | – | – | ||
| Futures (hedging exposure) | (514 | ) | (20,381 | ) | – | – | ||
| Call options | – | – | 1,623 | 27,854 | ||||
| Warrants | – | – | 138 | 140 | ||||
| (7,807 | ) | 167,469 | 41,773 | 188,075 |
12 Other Receivables
| 2016 | 2015 | |||
| £’000 | £’000 | |||
| Securities sold for future settlement | 3,171 | 2,771 | ||
| Accrued income | 296 | 581 | ||
| Other debtors and pre-payments | 64 | 36 | ||
| 3,531 | 3,388 |
13 Bank Loans
| 2016 | 2015 | |||
| £’000 | £’000 | |||
| Variable rate unsecured US dollar loan | ||||
| US dollar 150,000,000 @ 1.82% (2015:1.46%), repayable on 18 May 2016 | 104,315 | 101,014 |
On 14 February 2014, the Company renewed its US dollar 150,000,000 revolving loan facility agreement with Scotiabank Europe PLC for a further three years to 14 February 2017.
14 Other Payables
| 2016 | 2015 | |||
| £’000 | £’000 | |||
| Securities purchased for future settlement | 1,035 | 8,180 | ||
| Amount payable on share repurchases | 508 | – | ||
| Performance fee | 9,138 | 4,744 | ||
| Investment management, secretarial and administration fees | 2,407 | 2,509 | ||
| Other creditors and accrued expenses | 727 | 637 | ||
| 13,815 | 16,070 |
15 Share Capital
| 2016 | 2015 | |||||||
| Number of | Number of | |||||||
| shares | £’000 | shares | £’000 | |||||
| Issued, allotted and fully paid | ||||||||
| Ordinary Shares of 1 penny – held outside Treasury | ||||||||
| Beginning of the year | 571,254,480 | 5,712 | 571,354,480 | 5,713 | ||||
| Ordinary Shares repurchased into Treasury | (17,915,000 | ) | (179 | ) | (100,000 | ) | (1 | ) |
| End of the year | 553,339,480 | 5,533 | 571,254,480 | 5,712 | ||||
| Ordinary Shares of 1 penny – held in Treasury | ||||||||
| Beginning of the year | 100,000 | 1 | – | – | ||||
| Ordinary Shares repurchased into Treasury | 17,915,000 | 179 | 100,000 | 1 | ||||
| End of the year | 18,015,000 | 180 | 100,000 | 1 | ||||
| Total share capital | 5,713 | 5,713 |
The shares held in Treasury carry no rights to vote, to receive a dividend or to participate in a winding up of the Company.
During the year the Company repurchased 17,915,000 Ordinary shares (2015: 100,000) and placed them in Treasury. The cost of repurchasing these shares £27,412,000 (2015: £121,000) is charged to the Other Reserve.
16 Reserves
The share premium account represents the amount by which the proceeds from share issues, less the associated costs, exceed the nominal value of the Ordinary Shares issued. High Court approval was given on 21 April 2010 to cancel the account at that date and as a result £452,232,000 was transferred to the Other Reserve. Subsequently, the Company issued 157,654,480 Ordinary Shares resulting from its C share issue and 45,000,000 Ordinary Shares in separate issues pursuant to the authorities granted by shareholders. The share premium account cannot be used to fund share repurchases and it is not distributable by way of dividend.
The capital redemption reserve represents the nominal value of Ordinary Shares repurchased and cancelled. It cannot be used to fund share repurchases and it is not distributable by way of dividend.
The other reserve is a distributable premium reserve created on 21 April 2010 when High Court approval was given for the share premium account at that date to be cancelled. As a result £452,232,000 was transferred from the share premium account to the other reserve. It can be used to fund share repurchases.
The capital reserve represents realised gains or losses on investments and derivatives sold, increases and decreases in the fair value of investments and derivatives held and other income and costs recognised in the capital column of the Income Statement. It can be used to fund share repurchases and it is distributable by way of dividend. The Board has stated that it has no current intention to pay dividends out of capital.
The revenue reserve represents the net revenue surpluses recognised in the revenue column of the Income Statement that have not been distributed as dividends to shareholders. It is distributable by way of dividend.
17 Net Asset Value per Ordinary Share
The net asset value per Ordinary Share is based on net assets of £908,478,000 (2015: £944,135,000) and on 553,339,480 (2015: 571,254,480) Ordinary Shares, being the number of Ordinary Shares held outside Treasury in issue at the year end. It is the Company’s policy that Ordinary Shares held in Treasury will only be issued at a premium to net asset value per share and, therefore, the shares held in Treasury have no dilutive effect.
18 Financial Instruments
Management of risk
The Company’s investing activities in pursuit of its investment objective involve certain inherent risks. The Board confirms that there is an ongoing process for identifying, evaluating and managing the risks faced by the Company. The Board with the assistance of the Investment Managers, has developed a risk matrix which, as part of the internal control process, identifies the risks that the Company faces. Principal risks identified are market, performance, discount control, gearing and currency risks. Other risks identified are tax and regulatory risks and operational risks, including those relating to third party service providers covering investment management, marketing and business development, company secretarial, fund administration and operations and support functions. Risks are identified and graded in this process, together with steps taken in mitigation, and are updated and reviewed on an ongoing basis. Risks identified are shown in the Strategic Report in the Annual Report.
This Note is incorporated in accordance with IFRS 7: Financial Instruments: Disclosures and refers to the identification, measurement and management of risks potentially affecting the value of financial instruments.
The Company’s financial instruments comprise:
· Equity shares, equity linked notes and fixed-interest securities;
· Derivative instruments including CFDs, warrants, futures and options written or purchased on stocks and equity indices and forward currency contracts;
· Cash, liquid resources and short-term debtors and creditors that arise from its operations; and
· Bank borrowings.
The risks identified by IFRS 7 arising from the Company’s financial instruments are market price risk (which comprises interest rate risk, foreign currency risk and other price risk), liquidity risk, counterparty risk, credit risk and derivative instrument risk. The Board reviews and agrees policies for managing each of these risks, which are summarised below. These policies are consistent with those followed last year.
Market price risk
Interest rate risk
The Company finances its operations through share capital raised. In addition, the Company has long and short CFDs and a multicurrency revolving credit facility for US$150,000,000 expiring on 14 February 2017. The Company has drawn down the whole of this facility as disclosed in Note 13 above.
Interest rate risk exposure
The value of the Company’s financial instruments that are exposed to movements in interest rates are shown below:
| 2016 | 2015 | |||
| Exposure to financial instruments that bear interest | £’000 | £’000 | ||
| Long CFDs – exposure less fair value | 210,251 | 96,633 | ||
| Short CFDs – exposure plus fair value | 15,108 | 22,078 | ||
| Bank loans | 104,315 | 101,014 | ||
| 329,674 | 219,725 | |||
| Exposure to financial instruments that earn interest | ||||
| Cash at bank | 30,266 | 14,932 | ||
| Amounts held at futures clearing houses and brokers | 12,740 | 1,383 | ||
| 43,006 | 16,315 | |||
| Net exposure to financial instruments that bear interest | 286,668 | 203,410 |
Foreign currency risk
The Company’s net profit/(loss) after taxation and its net assets can be affected by foreign exchange rate movements because the Company has income, assets and liabilities which are denominated in currencies other than the Company’s functional currency which is UK sterling.
Three principal areas have been identified where foreign currency risk could impact the Company:
· movements in currency exchange rates affecting the value of investments and bank loans;
· movements in currency exchange rates affecting short-term timing differences, for example, between the date when an investment is bought or sold and the date when settlement of the transaction occurs; and
· movements in currency exchange rates affecting income received.
Currency exposure of financial assets
The Company’s financial assets comprise equity investments, long positions on derivative instruments, short-term debtors and cash and cash equivalents. The currency profile of these financial assets is shown below:
| 2016 | ||||||||||
| investments | ||||||||||
| held at | exposure | |||||||||
| fair value | to long | cash and | ||||||||
| through | derivative | other | cash | |||||||
| profit or loss | instruments | receivables* | equivalents | total | ||||||
| currency | £’000 | £’000 | £’000 | £’000 | £’000 | |||||
| Australian dollar | 2,564 | – | – | – | 2,564 | |||||
| Canadian dollar | 925 | – | – | – | 925 | |||||
| Chinese renminbi | 162,042 | – | – | 30,039 | 192,081 | |||||
| Hong Kong dollar | 545,809 | 204,668 | 3,382 | 87 | 753,946 | |||||
| Singapore dollar | 7,475 | – | – | – | 7,475 | |||||
| Taiwan dollar | 36,790 | – | 285 | 124 | 37,199 | |||||
| UK sterling | 37,247 | – | 58 | 3 | 37,308 | |||||
| US dollar | 195,026 | – | 12,546 | 13 | 207,585 | |||||
| 987,878 | 204,668 | 16,271 | 30,266 | 1,239,083 |
* Other receivables include amounts held at futures clearing houses and brokers.
| 2015 | ||||||||||
| investments | exposure | |||||||||
| held at fair | to long | cash and | ||||||||
| value through | derivative | other | cash | |||||||
| profit or loss | instruments | receivables* | equivalents | total | ||||||
| currency | £’000 | £’000 | £’000 | £’000 | £’000 | |||||
| Australian dollar | 4,962 | – | – | – | 4,962 | |||||
| Canadian dollar | 2,534 | 140 | – | – | 2,674 | |||||
| Chinese renminbi | 164,024 | – | – | 6,605 | 170,629 | |||||
| Hong Kong dollar | 538,576 | 115,950 | 4,403 | 5,090 | 664,019 | |||||
| Singapore dollar | 5,926 | 2,301 | – | – | 8,227 | |||||
| Taiwan dollar | 14,147 | – | – | – | 14,147 | |||||
| UK sterling | 36,968 | – | 368 | 3,212 | 40,548 | |||||
| US dollar | 233,906 | 46,927 | – | 25 | 280,858 | |||||
| 1,001,043 | 165,318 | 4,771 | 14,932 | 1,186,064 |
* Other receivables include amounts held at futures clearing houses and brokers.
Currency exposure of financial liabilities
The Company finances its investment activities through its ordinary share capital, reserves and borrowings.
The Company’s financial liabilities comprise short positions on derivative instruments, US dollar denominated bank loans and other payables. The currency profile of these financial liabilities is shown below.
| 2016 | ||||||||
| exposure | ||||||||
| to short | ||||||||
| derivative | US dollar | other | ||||||
| instruments | bank loans | payables | total | |||||
| currency | £’000 | £’000 | £’000 | £’000 | ||||
| Chinese renminbi | – | – | – | – | ||||
| Hong Kong dollar | 37,199 | – | 1,019 | 38,218 | ||||
| Singapore dollar | – | – | – | – | ||||
| Taiwan dollar | – | – | 20 | 20 | ||||
| UK sterling | – | – | 12,549 | 12,549 | ||||
| US dollar | – | 104,315 | 227 | 104,542 | ||||
| 37,199 | 104,315 | 13,815 | 155,329 | |||||
| 2015 | ||||||||
| exposure | ||||||||
| to short | ||||||||
| derivative | US dollar | other | ||||||
| instruments | bank loans | payables* | total | |||||
| currency | £’000 | £’000 | £’000 | £’000 | ||||
| Chinese renminbi | – | – | 720 | 720 | ||||
| Hong Kong dollar | 22,757 | – | 7,072 | 29,829 | ||||
| Singapore dollar | – | – | 1 | 1 | ||||
| Taiwan dollar | – | – | 52 | 52 | ||||
| UK sterling | – | – | 7,703 | 7,703 | ||||
| US dollar | – | 101,014 | 1,822 | 102,836 | ||||
| 22,757 | 101,014 | 17,370 | 141,141 |
* Other payables include overseas capital gains tax payable.
Other price risk
Other price risk arises mainly from uncertainty about future prices of financial instruments. It represents the potential loss the Company might suffer through price movements in its investment positions.
The Investment Managers are responsible for actively monitoring the portfolio selected in accordance with the overall asset allocation parameters described above and seek to ensure that individual stocks meet an acceptable risk/reward profile. Other price risks arising from derivative positions, mainly to do with underlying exposures, are assessed by the Investment Managers’ specialist derivative instruments team.
The Board meets quarterly to review the asset allocation of the portfolio and the risk associated with particular industry sectors within the parameters of the investment objective.
Liquidity
The Company’s assets mainly comprise readily realisable securities which can be sold to meet funding commitments if necessary. Short-term flexibility is achieved by the use of overdraft facilities if required. The Company has the facility to borrow up to US dollar 150,000,000 until 14 February 2017. The current borrowing is shown in Note 13 above. Other financial liabilities are repayable within one year.
Counterparty risk
Certain of the derivative instruments in which the Company may invest are not traded on an exchange but instead will be traded between counterparties based on contractual relationships, under the terms outlined in the International Swaps Dealers Association’s (“ISDAâ€) market standard derivative legal documentation. These are known as Over The Counter (“OTCâ€) trades. As a result the Company is subject to the risk that a counterparty may not perform its obligations under the related contract. In accordance with the risk management process which the Investment Managers employ, they will seek to minimise such risk by; only entering into transactions with counterparties which they believe to have an adequate credit rating at the time the transaction is entered into, by ensuring that formal legal agreements covering the terms of the contract are entered into in advance, and through adopting a counterparty risk framework which measures, monitors and manages counterparty risk by the use of internal and external credit agency ratings and evaluates derivative instrument credit risk exposure.
For OTC derivative transactions, collateral is used to reduce the risk of both parties to the contract. Collateral is managed on a daily basis for all relevant transactions. At 31 March 2016 £3,121,000 (2015: £39,032,000) was held by the broker, in government bonds in a segregated collateral account on behalf of the Company, to reduce the credit risk exposure of the Company and £12,740,000 (2015: £1,383,000), was held by the Company in cash, shown as Amounts held at futures clearing houses and brokers on the Balance Sheet, in a segregated collateral account on behalf of the broker, to reduce the credit risk exposure of the broker.
Credit risk
Financial instruments may be adversely affected if any of the institutions with which money is deposited suffer insolvency or other financial difficulties. All transactions are carried out with brokers that have been approved by the Investment Managers and are settled on a delivery versus payment basis. Limits are set on the amount that may be due from any one broker and are kept under review by the Investment Managers. Exposure to credit risk arises on outstanding security transactions, derivative instruments and cash at bank.
Derivative instruments risk
A Derivative Instrument Charter, including an appendix entitled Derivative Risk Measurement and Management, details the risks and risk management processes used by the Investment Managers. This Charter was approved by the Board and allows the use of derivative instruments for the following purposes:
· to gain exposure to equity markets, sectors or individual investments;
· to hedge equity market risk in the Company’s investments with the intention of mitigating losses in the event of market falls;
· to enhance portfolio returns by writing call and put options; and
· to take short positions in equity markets, which would benefit from a fall in the relevant market price, where the Investment Managers believe the investment is overvalued. These positions distinguish themselves from other short exposures held for hedging purposes since they are expected to add risk to the portfolio.
The risk and investment performance of these instruments are managed by an experienced, specialist derivative team of the Investment Managers using portfolio risk assessment tools for portfolio construction.
RISK SENSITIVITY ANALYSIS
Interest rate risk sensitivity analysis
Based on the financial instruments held and interest rates at the balance sheet date, an increase of 0.25% in interest rates throughout the year would have increased the loss after taxation for the year and decreased the net assets of the Company by £717,000 (2015: decreased the profit after taxation and decreased the net assets by £509,000). A decrease of 0.25% in interest rates throughout the year would have had an equal but opposite effect.
Foreign currency risk sensitivity analysis
Based on the financial assets and liabilities held and the exchange rates ruling at the balance sheet date, a strengthening of the UK sterling exchange rate by 10% against other currencies would have increased the net loss after taxation for the year (2015: decreased the net profit) and decreased the net assets of the Company by the following amounts:
| 2016 | 2015 | |||
| currency | £’000 | £’000 | ||
| Australian dollar | 233 | 451 | ||
| Canadian dollar | 84 | 243 | ||
| Chinese renminbi | 17,462 | 15,446 | ||
| Hong Kong dollar | 49,132 | 51,296 | ||
| Singapore dollar | 680 | 550 | ||
| Taiwan dollar | 3,380 | 1,281 | ||
| US dollar | 9,368 | 13,577 | ||
| 80,339 | 82,844 |
Based on the financial assets and liabilities held and the exchange rates ruling at the balance sheet date, a weakening of the UK sterling exchange rate by 10% against other currencies would have decreased the net loss after taxation for the year (2015: increased the net profit) and increased the net assets of the Company by the following amounts:
| 2016 | 2015 | |||
| currency | £’000 | £’000 | ||
| Australian dollar | 285 | 551 | ||
| Canadian dollar | 103 | 297 | ||
| Chinese renminbi | 21,342 | 18,879 | ||
| Hong Kong dollar | 60,050 | 62,695 | ||
| Singapore dollar | 831 | 672 | ||
| Taiwan dollar | 4,131 | 1,566 | ||
| US dollar | 11,449 | 16,594 | ||
| 98,191 | 101,254 |
Other price risk sensitivity analysis
Changes in market prices affect the net profit/(loss) after taxation for the year and the net assets of the Company. Details of how the Board sets risk parameters and performance objectives are disclosed in the Strategic Report, in the Annual Report.
An increase of 10% in the share prices of the investments held at fair value through profit or loss at the balance sheet date would have decreased the loss after taxation for the year and increased the net assets of the Company by £98,788,000 (2015: increased the profit after taxation and increased the net assets by £100,104,000). A decrease of 10% in the share prices of the investments designated at fair value through profit or loss would have had an equal but opposite effect.
Derivative instruments exposure sensitivity analysis
The Company invests in derivative instruments to gain exposure to the equity market. An increase of 10% in the share prices of the investments underlying the derivative instruments at the balance sheet date would have decreased the loss after taxation for the year and increased the net assets of the Company by £16,747,000 (2015: increased the profit after taxation and increased the net assets by £14,256,000). A decrease of 10% in the share prices of the investments underlying the derivative instruments would have had an equal but opposite effect.
Fair Value of Financial Assets and Liabilities
Financial assets and liabilities are stated in the Balance Sheet at values which are not materially different to their fair values. As explained in Note 2 (l) and (m) above, investments and derivative instruments are shown at fair value. In the case of cash and cash equivalents, book value approximates to fair value due to the short maturity of the instruments. The exception is the US dollar denominated bank loan, its fair value having been calculated by discounting future cash flows at current US dollar interest rates.
| 2016 | 2015 | |||||||
| fair value | book value | fair value | book value | |||||
| £’000 | £’000 | £’000 | £’000 | |||||
| Variable rate unsecured loan of US dollar 150,000,000 | 104,790 | 104,315 | 101,382 | 101,014 |
Fair Value Hierarchy
Under IFRS 13: Fair Value Measurement, the International Accounting Standards Board requires investment companies to disclose the fair value hierarchy that classifies financial instruments measured at fair value at one of three levels, according to the relative reliability of the inputs used to estimate the fair values.
| Classification | Input |
| Level 1 | Valued using quoted prices in active markets for identical assets |
| Level 2 | Valued by reference to valuation techniques using observable inputs other than quoted prices included within level 1 |
| Level 3 | Valued by reference to valuation techniques using inputs that are not based on observable market data |
Categorisation within the hierarchy has been determined on the basis of the lowest level input that is significant to the fair value measurement of the relevant asset. The valuation techniques used by the Company are explained in the Accounting Policies Notes 2 (l) and (m) above. The table below sets out the Company’s fair value hierarchy:
| 2016 | ||||||||
| level 1 | level 2 | level 3 | total | |||||
| Financial assets at fair value through profit or loss | £’000 | £’000 | £’000 | £’000 | ||||
| Investments – shares | 963,712 | – | 20,317 | 984,029 | ||||
| Investments – equity linked notes | – | 3,849 | – | 3,849 | ||||
| Derivative instruments | – | 20,275 | – | 20,275 | ||||
| 963,712 | 24,124 | 20,317 | 1,008,153 | |||||
| Financial liabilities at fair value through profit or loss | ||||||||
| Derivative instruments | – | (28,082 | ) | – | (28,082 | ) | ||
| Financial liabilities at amortised cost | ||||||||
| Bank loan | – | (104,315 | ) | – | (104,315 | ) |
| 2015 | ||||||||
| level 1 | level 2 | level 3 | total | |||||
| Financial assets at fair value through profit or loss | £’000 | £’000 | £’000 | £’000 | ||||
| Investments – shares and rights | 946,209 | – | 160 | 946,369 | ||||
| Investments – equity linked notes | – | 54,674 | – | 54,674 | ||||
| Derivative instruments | 138 | 43,769 | – | 43,907 | ||||
| 946,347 | 98,443 | 160 | 1,044,950 | |||||
| Financial liabilities at fair value through profit or loss | ||||||||
| Derivative instruments | – | (2,134 | ) | – | (2,134 | ) | ||
| Financial liabilities at amortised cost | ||||||||
| Bank loan | – | (101,382 | ) | – | (101,382 | ) |
The table below sets out the movements in level 3 investments during the year:
| 2016 | 2015 | |||
| level 3 | level 2 | |||
| Movements in level 3 investments during the year | £’000 | £’000 | ||
| Level 3 investments at the beginning of the year | 160 | 33,245 | ||
| Purchases at cost | 17,664 | 160 | ||
| Transfers into level 31 | 8,767 | – | ||
| Transfers out of level 32 | – | (33,245 | ) | |
| Unrealised profits recognised in the Income Statement | 3,392 | – | ||
| Losses recognised in the Income Statement | (9,666 | ) | – | |
| Level 3 investments at the end of the year | 20,317 | 160 |
1 Financial instruments are transferred into level 3 on the date they are suspended or when they have not traded for thirty days.
2 Financial instruments are transferred out of level 3 when they commence trading on an active market.
19 Capital Resources and Gearing
The Company does not have any externally imposed capital requirements. The financial resources of the Company comprise its share capital, reserves and gearing, which are disclosed in the Balance Sheet above. It is managed in accordance with its investment policy and in pursuit of its investment objective, both of which are detailed in the Strategic Report in the Annual Report. The principal risks and their management are disclosed in the Strategic Report in the Annual Report and in Note 18 above.
The Company’s gearing at the year end is set out below:
| 2016 | 2015 | |||
| Gross asset exposure | £’000 | £’000 | ||
| Investments | 987,878 | 1,001,043 | ||
| Long derivatives | 204,668 | 165,318 | ||
| Total long exposures before hedges | 1,192,546 | 1,166,361 | ||
| Less: short derivatives hedging the above | (37,199 | ) | – | |
| Total long exposures after the netting of hedges | 1,155,347 | 1,166,361 | ||
| Short derivatives | – | 22,757 | ||
| Gross Asset Exposure | 1,155,347 | 1,189,118 | ||
| Net assets | 908,478 | 944,135 | ||
| Gearing (Gross Asset Exposure in excess of Net Assets) | 27.2 | % | 25.9 | % |
20 Transactions with the Managers and Related Parties
FIL Investment Services (UK) Limited is the Company’s Alternative Investment Fund Manager and has delegated portfolio management to FIL Investment Management (Hong Kong) Limited and FIL Investments International. They are all Fidelity group companies.
Details of the fee arrangements are given in the Directors’ Report in the Annual Report. During the year management fees of £9,138,000 (2015: £8,094,000), performance fees of £9,138,000 (2015: £4,744,000) and accounting, administration and secretarial fees of £600,000 (2015: £600,000) were payable to the Managers. At the balance sheet date, management fees of £2,257,000 (2015: £2,359,000), performance fees of £9,138,000 (2015: £4,744,000) and accounting, administration and secretarial fees of £150,000 (2015: £150,000) were accrued and included in other payables. Fidelity also provides the Company with marketing services. The total amount payable for these services was £230,000 (2015: £174,000). At the balance sheet date £80,000 (2015: £99,000) was accrued and included in other payables.
Disclosures of the Directors’ interests in the ordinary shares of the Company and fees and taxable benefits relating to reasonable travel expenses payable to the Directors are given in the Directors’ Remuneration Report in the Annual Report. The Directors received compensation of £179,000 (2015: £167,000). In addition to the fees and taxable benefits disclosed in the Directors’ Remuneration Report, this amount includes £15,000 (2015: £11,000) of employers’ National Insurance Contributions paid by the Company.
Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) is incorporated into, or forms part of, this announcement.
For further information, please contact:
Bonita Guntrip – Senior Company Secretary
01737 837320
FIL Investments International
ENDS
A copy of the Annual Report and Accounts will shortly be submitted to the National Storage Mechanism and will be available for inspection at www.morningstar.co.uk/uk/NSM
The Annual Report and Accounts will also be available on the Company's website at www.fidelityinvestmenttrusts.com where up to date information on the Company, including daily NAV and share prices, factsheets and other information can also be found
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