The latest full-year results show Nicholls has generated a 101.8% total return from the highly geared portfolio of Chinese stocks since he took it over from Bolton in April 2014. Over the same period the MSCI China stock market index has gained 60.6%.
The figures confirm that after a troubled start FCSS has established itself as a volatile but good performing single country fund.
It was a hugely popular launch, attracting £460 million in 2010 from investors fascinated by Bolton, a veteran UK and Europe fund manager, coming out of retirement to try his hand at investing in China.
A £166 million C-share issue in February 2011 marked an early high point with its net asset value slumping 31.5% that year as the fund suffered from the fallout of the global debt crisis and from a series of accounting scandals at some of the US-listed China stocks it held.
Bolton stayed on to stabilise the situation, however, with the NAV recovering 13.3% in 2012 and by 35.9% the following year. In 2014, when Nicholls succeeded Bolton, the portfolio rose by nearly a third, with dividends included in the total return, and in the following two years advanced 12.4% and 17.5%. In the first five months of 2017 the NAV has surged 18.7%.
According to Morningstar, that leaves the £1.2 billion trust with an annualised three-year return to the end of May of 29.6%. This is a a bit more than the five-year 27% annualised return which includes some of Boltons period in charge.
The annualised total return shareholders have actually received has been slightly less, at 28.5% over three years and 24.7% over five years. This is because of the discount - or the gap between the NAV and share price - which currently stands at 14%. Nevertheless, these are impressive returns.
Another strong year
In the 12 months to 31 March, the results show a NAV total return of 38.8%, marginally ahead of index gains of 37.6%. Shareholders did better, receiving a total return of 45.8% as the discount narrowed from 17% to 13% as the share price rose faster than the underlying portfolio.
Nicholls said the Chinese market witnessed large declines in April and May last year but economic fundamentals ‘have clearly improved’ although overhangs to sentiment still remain from ‘old China’ industries and concerns about overproduction of steel and coal.
The government has reformed the ‘supply-side’ of these industries and cut back production, helping to stabilise the economy and reflected in GDP growth of 6.9% in the first quarter of the year, said Nicholls.
He is more concerned about the growth in credit, a problem that China is failing to shake off despite efforts from the People’s Bank of China. Nicholls said corporate debt has slowed and a shift of focus towards reforming lending will help.
The banking sector is part of Nicholls’ focus on ‘new economy’ sectors that will benefit from the growth of the middle classes, rising wages and increasing consumption in China. Nicholls said consumers will continue to be an ‘important economic driver over the next five to 10 years’.
To take advantage of this trend Nicholls invested in Yihai, which manufactured condiments for hot pot meals, at its flotation in July last year
Following a shareholder vote last year the trust is now able to hold up to 10% of the portfolio in unlisted shares and Nicholls has invested in four unlisted companies, representing 4% of the portfolio.
Ride-sharing company Xiaoju Kuzizhi, which acquired Uber China last year, was the first unlisted company invested in, followed by China Internet Plus, which is a leader in ‘offline-to-online services’ that is aiming to be ‘the Alibaba of the service sector in areas like food delivery, restaurant reservations and ticket booking’, said Nicholls.
Fresh food e-commerce company Yiguo E-Commerce was the third company to be added and Nicholls said it operates in an ‘underdeveloped industry’ that offers ‘huge growth potential as consumers become more health conscious while also seeking greater convenience’.
The fourth unlisted position is in app developer service provider and big data platform Jiguang, which services 400,000 apps with 200,000 developers.
It has been the more established positions in larger companies that have helped the trust to outperform this year and one of the largest contributors was pharmaceutical company Hutchison China MediTech (HCM), listed on the UK AIM market, which returned over 70% over the year.
Nicholls said it continues to develop an ‘exciting pipeline, including a number of advanced oncology drugs where it is teaming up with global multi-nationals like AstraZeneca’ and has had positive results for a colon cancer drug that caused its share price to rally.
China Sanjiang Fine Chemical was also a ‘major contributor’ over the year along with car dealership China Meidong Auto.
Financials distracted from the performance, as the largest overweight position in the trust, relative to the MSCI China index is China Pacific Insurance, which is facing concerns about it property and casualty business performance in the wider context of increasing regulatory scrutiny in the insurance sector.
Nicholls said the concerns were ‘overdone’ and that the company is ‘significantly undervalued’.
While challenges remain, he said the economy was ‘dynamic’ with ‘huge variation in trends between winners and losers – fertile ground for bottom up stock pickers such as myself’ and there is still further to go in China.
‘While the market has moved up, valuations on the whole remain compelling in a global context,’ he said.
‘One wonders if what has become a relatively stable and predictable policy environment compared to much of the west might also start to get reflected in valuations.’
Nicholls predicted the ‘significant’ gap between China’s share of the global economy and its share within global stockmarkets would close and ‘it is a matter of time before A-shares move into global indices’.