... or is now the time to back Fidelity’s veteran fund manager?
The launch of the Fidelity China Special Situations (LSE: FCSS) investment trust in 2010 was the razzmatazz fund launch of that year. It marked the return to active management of one of the UK's most successful fund managers, Anthony Bolton.
Bolton had run the UK-focused Fidelity Special Situations fund from 1979 to 2007, turning an outlay of £1,000 into £148,200 during his 27-year tenure.
Having moved to a hands-off role as President of Investments at Fidelity in 2007, he threw himself back into stockpicking in 2010, convinced that China represented "one of the best investment opportunities of the next decade".
Foolish opinion was divided on the advisability of backing Bolton's new China venture, and no doubt that will still be the case after the trust's second-year results, which were released last week.
Annus horribilis
For the year ended 31 March 2012, FCSS reported an 18.5% fall in net asset value (NAV) -- from £684m to £559m -- under-performing the MSCI China benchmark index by 6%. The share price dropped an even more precipitous 26.4%. Over the same period, the humble FTSE 100 index (UKX) managed a 1.2% gain.
FCSS's exposure to small- and medium-sized companies was the biggest detractor from performance, aided and abetted by borrowing money from the bank to magnify the investment return -- negatively in this case.
The trust tells us that the exposure to smaller companies, the borrowings -- in the shape of a fully drawn down $150m (£94m) facility -- and the use of derivatives to achieve further gearing (to the tune of £39m) "are expected to enhance the performance of [FCSS] relative to the market in more favourable conditions". Well, yes, one would certainly hope so! FCSS is currently the most highly leveraged investment trust I can find in the emerging markets sector!
Bolton's inexperience in China has certainly taken its toll on the trust's performance to date, and cynics might argue that he's recklessly trying to claw back his losses and reputation. However, while I've never championed FCSS, I will defend Bolton's gearing tactics.
Shareholders should have been aware all along that Bolton is a super bull on China and, as a contrarian investor, is always likely to make his biggest bull bets -- including gearing up to the max -- when there's fear on the trading floors of the Shanghai and Hong Kong stock markets and his fund is looking in a sorry state.
Bolton's stocks
Bolton continues to pursue the four main planks of his investment strategy:
- To be exposed mainly to the consumption and service sectors that depend on the domestic economy in China: "After two years here, I feel even more strongly about the attractions of these areas."
- To focus on private medium- and small-sized businesses rather than large state-owned enterprises: "These are the entrepreneur-run businesses on which I believe China's long-term prospects are based."
- To find business models with which he is familiar from his experience of investing in the UK and continental Europe: "These are the models that I know work."
- To buy shares on reasonable or, if possible, cheap valuations: "I believe that there are many bargains available among the smaller stocks … Valuations are still near their 10-year lows and sentiment has again become very negative."
In his manager's report within this year's results, Bolton details his thoughts on 14 companies in his portfolio to give shareholders a greater understanding of the types of businesses he focuses on.
These range from £1.4bn shoe retailer Daphne International to £90m magazine publisher Modern Media, but all 14 are fascinating plays on China's domestic economy and worth reading about.
One that particularly caught my eye, because it's listed on London's AIM market, is Hutchison China MediTech (LSE: HCM). The group has three main businesses: drug discovery; traditional Chinese medicines; and food, beauty and baby care products.
Bolton says: "The valuation of the shares can be justified by the latter two businesses alone while the drug discovery business, which could be very valuable if it finds a winner, is thrown in effectively for free."
Bolton gave Hutchison's market cap as £230m at the time, so the company is now even cheaper at £210m with the shares trading at 405p.
Year of the Ant
Anthony Bolton's higher-risk approach in both company size and gearing contrasts with a more conservative stance of two alternatives I've favoured over FCSS in the past: the modestly geared rival investment trust JP Morgan Chinese IT (LSE: JMC), and the ungeared OEIC (open-ended investment company) First State Greater China Growth, both of which have experienced local management teams.
Having said that, if you are really bullish on China's prospects, this year could be a great one to back Bolton, who has extended his commitment to managing FCSS until at least 2014.
Bolton now has over two years' of experience in China under his belt and has made plenty of mistakes from which he will have learnt. FCSS's shares are trading at 73.6p, which is a 5% discount to NAV and a massive 26% discount to the price investors paid for the shares when the trust launched in April 2010.
Has the time come to be bullish on Bolton or has Fidelity's veteran manager been shanghaied by China? You can let me know your views in the comments box below!
Finally, I should tell you that Bolton's personal stake in his fund is down about £1 million. If you want to make £1 million, get yourself the Motley Fool special report -- "10 Steps To Making A Million In The Market" -- which is free to download right now.
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> G A Chester does not own shares in any of the companies mentioned in this article.
