China Special Situations
Some time ago, Fidelity International announced that the all-star former manager of its UK-based Special Situations Fund, Anthony Bolton, would be moving to Hong Kong and starting up a closed-end China Special Situations fund (FCSS: LN), to be listed on the London Stock Exchange. It debuted in April 2010.
the “China setback”
The other day, the Financial Times carried an article talking about the fund’s “China setback.” In an interview with the paper, Bolton disclosed that his fund had lost money on two US-listed Chinese companies accused of fraud, as well as on put options he had bought on the main Korean stock index.
According to Morningstar (the documents I refer to in this paragraph are available on the Fidelity International website), FCSS has lost 12.22%, year to date. This compares unfavorably with a decline of 3.08% by its benchmark MCSI China index over the same period.
On a one-year basis, the fund is up 2.8% vs. an index gain of 3.26%. That’s a lot better. Nevertheless, the FCSS figures contrast sharply with Fidelity’s own China Region fund (FXKCX), which is presumably supported by the same research staff, and which is up 18.34% over the past year.
Before the launch of the China Special Situations fund, much was made of Mr. Bolton’s lack of experience with China-related investing (although the prospectus for FCSS states he has been investing in China stocks since 2004). I don’t think this in itself is an important issue. (To be clear, I don’t know Mr. Bolton personally and have no knowledge of the details of his investing success in the UK.) However, even in a world where every national stock market has its own quirks, the UK has always struck me as a particularly idiosyncratic one. So there is a question in my mind how well experience in the UK travels.
–The UK market is very value- and dividend-oriented.
–It doesn’t appreciate technology.
–Rules of conduct for investors and listed firms are strict and well-enforced; to my knowledge there’s nothing like Denver or Perth there.
–Much in the way old zaibatsu relationships still count for something in Japan–the relationship between investment banker and company still has an effect on the quality of information the market receives.
–Understanding who’s who and getting tapped into the best analysis, which to some extent depends on local social relationships, creates a big advantage but requires a lot of time and effort.
China, in contrast, strikes me as much more a no-holds-barred, Wild West kind of market. It has a strong growth stock orientation, which makes sense given the rapid expansion of the domestic Chinese economy and the preferences of Hong Kong-based investors, who are the stock market model for the mainland.
looking at the FCSS portfolio
First, there isn’t enough current detail available about FCSS’s holdings to say a lot for certain. Nevertheless:
–To me, the most striking observation is the more than 15 percentage point advantage that Fidelity-managed FXKCX has had over FCSS during the past 12 months, even though both presumably have the same research information.
–FCSS had 15.7% of its portfolio in US-listed China stocks. That’s a big bet, and one that apparently hasn’t worked out. It’s also a very unusual one, in my experience. Why?
What motivates a company to list in a foreign market and take on the associated regulatory burden? Invariably, it’s because the company can get a higher price for its shares abroad than at home. Usually, this is because the company is maturing and local-market investors have turned cool toward the shares, or because there’s some flaw in the company’s operating model (like that it’s a securities fraud) that locals would much more easily detect than foreigners.
–Although FCSS is heavily skewed toward small companies, the top ten holdings, which make up a third of the portfolio, don’t have much of a special situations look to them (see my post on special situations). They’re mostly large-cap financials like HSBC, Bank of China or Ping An Insurance; or other giants, like China Unicom, the big telecoms company.
–Usually when investors talk about China or “greater China,” they mean the mainland, Hong Kong, Macau and Taiwan. South Korea doesn’t enter into the discussion. What was Mr. Bolton doing in speculating about short-term movements in the Seoul market?
–Year to date, FCSS has lost about 12 percentage points to its benchmark index. According to the FT, the fund held 30 US-listed Chinese companies, representing 15%+ of the portfolio. Of them, six were so-called “reverse merger” companies–ones where all the trouble has been. FCSS sold “several” of these, including the two accused of fraud.
On average, the weighting in each of these stocks would be about 50 basis points (.5%). Selling five at a loss of 100%, which is doubtless far worse than what actually happened, would mean a performance loss of 2.5%. That doesn’t go very far in explaining the year to date underperformance.
–For that matter, the Kospi is up about 3% year to date. So the existence of the curious Kospi puts don’t explain much either.
Even the most successful portfolio manager has times when he underperforms. That’s just a fact of life. It’s also possible that the FT reporter didn’t understand what Mr. Bolton was telling him in their interview.
What’s perplexing in this case, though, is that the extent of the underperformance is large and the reported explanation doesn’t seem to really address it. I think there has to be a lot more to the story.