Fidelity China Special Situations PLC Regulatory News (FCSS)

Fidelity China Special Situations Plc - Annual Financial Report

PR Newswire

London, May 30

FIDELITY CHINA SPECIAL SITUATIONS PLC 

Final Results for the year ended 31 March 2022

Financial Highlights:

majority of short positions in the wake of the market corrections.

Contacts

For further information, please contact:

Natalia de Sousa

Company Secretary

01737 837846

FIL Investments International

Chairman’s Statement

The reporting year proved challenging for investors in China – driven by four key factors. China’s apparent recovery from COVID-19 stalled and it returned to its zero-COVID policy, reinstating restrictions on movement and lockdown isolation requirements in several major cities. Fears about China’s slowing growth and debt burden weighed on equities; as did an increase in geopolitical tensions, linked in part to Russia’s invasion of Ukraine. Regulatory crackdowns also held back performance, causing sharp sell-offs in sectors linked to President Xi Jinping’s Three Mountains policy to increase equality in education (and internet), health care and property sectors.

Our Benchmark Index, the MSCI China Index, fell by 29.3% in the reporting year giving up all of the gains it had made during the previous twelve months. The net asset value (“NAV”) per share fell by 34.9% where the gearing effect (-10.9%) outweighed the gains from stock selection (+6.6%). During the same period, the Company’s share price fell by 39.2% as the discount widened to 7.5% from 1.1% at the end of the last reporting year.

The NAV and share price have both been particularly volatile during the last two years since the global pandemic was declared and we will no doubt see further volatility in the future. However, it should be noted that the share price and NAV as at 31 March 2022 of 252.00p and 272.52p respectively are still some way ahead of that at the same date in 2020 (216.00p and 236.27p) when the global pandemic was declared.

At a time when the world is experiencing volatility and uncertainty both politically and in its financial markets, investors will be re-appraising the makeup of their portfolios. Questions are asked, such as “Should a diversified portfolio have direct exposure to China?” “And if so, how?”

The Board continues to believe that a direct exposure to China is an important constituent of a diversified portfolio. Not only is China the second largest economy in the world but its Gross Domestic Product (“GDP”) has for many years grown at a faster rate than the world average and it is projected to continue to do so. A geographically diversified portfolio needs to have exposure to this growth.

Fidelity China Special Situations has set out its stall to offer a “one stop shop” to investors to provide the China content of their portfolios.

Our Portfolio Manager, Dale Nicholls, concentrates on identifying those parts of the Chinese economy which are growing the fastest. He invests in the large capitalisation stocks such as Alibaba Group Holding and Tencent Holdings whose businesses continue to grow strongly. He also uses his large research team on the ground in China to seek out attractively priced medium and smaller capitalisation companies which will generate returns as they grow. Our top ten holdings are described in the Annual Report.

Making use of the closed ended nature of an investment trust, Dale can also invest up to 15% of the portfolio in unlisted companies taking advantage of their early stage growth before they become listed on the public markets. During the year, two of our unlisted holdings achieved their IPO, each recording a significant uplift over their original cost. However, since the dates of their IPOs, the fall in the markets has affected their prices. Subsequent to the year end, the Company converted its preference shares in the ride hailing company Xiaoju Kuaizhi (Didi Chuxing) into American Depositary Shares (ADS). Further details are in Note 22 below. The valuation of Didi has been particularly affected by the fall in the markets, concerns over US listings, and increased regulation requirements. Three more investments were added to the unlisted part of the portfolio. Our unlisted investments are described in the Annual Report.

Because of our confidence in the long-term growth characteristics of the Chinese economy we include an element of gearing in the portfolio. This ensures that positive long-term returns are amplified but does result in increased volatility in the Net Asset Value and Share Price as it also accentuates losses in a falling market, as happened this year.

Dale Nicholls, in his report, describes those parts of the Chinese economy where he perceives the greatest growth, and comments on some of the specific investments he holds including his rationale for holding his five largest investments, which comprise 29.0% of his portfolio.

The Board is mindful of the risks of investing in a single emerging market and monitors those risks, both current risks and our perception of emerging risks. These risks are set out below. We believe, however, that those risks are outweighed by the opportunities of investing in China, and, in particular, in investing in Fidelity China Special Situations.

By investing in the domestic economy, Dale mitigates much of the geopolitical risk of investing in China. The growth of the middle class from a population of 1.4 billion people provides a momentum to consumer spending. Although, in a year when this has been reduced by the effects of the pandemic, Dale has sought value in other parts of the economy which he describes in his report.

The Board believes that the size and quality of Fidelity’s research team gives the Manager a considerable advantage. Market dislocations create stock specific pricing anomalies and these can only be identified by extensive and rigorous research. Research also enables the Manager to position the portfolio to try and mitigate regulatory changes from the Chinese government some of which can be predicted from the nature of a centrally planned economy.

Board visit to ChinaIn the years prior to the pandemic, the Board visited China each year to observe the Manager and his team in action, to meet the Fidelity analysts and also to meet some of the Companies in which we are invested. Last year, for the second time, we were unable to do that but had virtual visits in which we used video conferencing to meet with a combination of the Fidelity team, market commentators and some investee companies.

Among the companies we met was Bilibili, a video sharing internet company based in Shanghai, themed around animation, comics, and games, with whom the Portfolio Manager discussed limiting the impact from regulations, in particular, possible restrictions on “time spent” for minors on video content as seen on games.

We also heard from the management team of Huazhu Group, a hotel management company in China, that was ranked as the No.7 Hotel Group around the world in 2021 by Hotels.com; and from BC Technology Group which specialises in digital assets and blockchain platforms.

The Board was, once again, impressed by the breadth and depth of Fidelity’s team, spending time not only with the Manager and the analysts but also with the Global Head of Stewardship and Sustainable Investing, who is based in Singapore.

I would like to take this opportunity to reiterate the Board’s confidence in our Portfolio Manager, Dale Nicholls, and his team, in their skills and proven track record of identifying growth opportunities in the Chinese marketplace.

Environmental, Social and Governance (ESG) Investment and Climate ChangeCOP26 was an important global event in November 2021 where governments, businesses, climate experts and campaigners gathered for discussions and negotiations to tackle climate change. It provided a platform to attempt to align and co-ordinate international efforts in the fight against the climate crisis. There is increasing concern about global warming, and a focus on serious efforts to counter its effects. There was progress in the form of commitments and initiatives across a wide range of areas from deforestation to clean energy transition but more needs to be done. Businesses for their part are under pressure to ensure that their activities are environmentally sustainable, as well as demonstrating social responsibility and good corporate governance. Continuing deterioration in the climate brings investment risk into our portfolio. Fidelity International continues to evolve its approach to ESG and has a new climate investing policy as well as sustainable investing voting principles and guidelines and is making further improvements to its proprietary forward-looking ESG and climate ratings.

The growing body of middle-class consumers in China who care about the environmental and social footprints of what they buy means that companies need to take sustainability more seriously. The rise of sustainable investing offers further incentives for companies to step up their ESG efforts for the sake of easier financing. Given this confluence of factors, it is unsurprising that companies are generally willing and, at times, keen to engage with investors on ESG issues.

The evaluation of ESG factors are a core part of our Portfolio Manager’s investment process and he continues to see progress regarding the level of engagement and transparency with Chinese companies. Sustainability factors are key topics of conversation with companies and many management teams are looking at ways to generate a more sustainable outcome for their companies. Although China continues to lag most other major markets in this area, we are encouraged by the fast rates of improvement which we are seeing. China’s regulators are engaging with companies to improve the disclosure of ESG metrics to align themselves more with these standards in Hong Kong. Not only is this a good outcome globally, but we also believe that progress on better ESG practices could be a key source of performance for the portfolio over the longer-term.

Fidelity International has a proprietary sustainability ratings system leveraging its internal research and interactions with issuers. The ratings are designed to generate a forward-looking and holistic assessment of ESG risks and opportunities based on sector specific performance indicators. Analysts quantify the direction of change of companies’ ESG performance (positive, neutral or negative trajectory) and rate the companies using a scale of A to E. The Board pays close attention to the ratings of underlying portfolio companies and challenges the Portfolio Manager and his team on any stocks with lower ratings. The ratings of the companies within the portfolio are well ahead of the broader market and continue to improve.

Dale Nicholls outlines his approach to this important subject in his report and what this means for the Company’s investment portfolio. The Fidelity group of companies (including the Manager) has embedded ESG factors in its investment decision making process. Further details are in the Annual Report which show how the Company is positioned in terms of ESG.

GearingThe Company has a three-year unsecured fixed rate facility agreement with Scotiabank Europe PLC for US$100,000,000. The interest rate is fixed at 2.606% per annum until the facility terminates on 14 February 2023.

To achieve further gearing, the Company uses contracts for difference (“CFDs”) on a number of holdings in its portfolio. Further details are in Note 20 below.

As at 31 March 2022, the Company’s Gross Gearing, which is Gross Asset Exposure in excess of Net Assets, was 26.1% (2021: 26.2%). The level of Gross Gearing is determined by the Manager within the limit set by the Board of 30%. Net Gearing, which nets off short positions, was 23.5% at the year end (2021: 18.4%).

DividendOur investment objective is to achieve long-term capital growth. Nevertheless, the Company has been able to increase the dividend per share every year since the Company launched. With interest rates being low, the Directors recognise that the dividend has become a more important part of the total return to shareholders.

The Board recommends a final dividend of 5.50 pence per share for the year ended 31 March 2022 for approval by shareholders at the Annual General Meeting (“AGM”) to be held on 20 July 2022. This represents an increase of 17.5% over the 4.68 pence paid in respect of the prior year. The dividend will be payable on 27 July 2022 to shareholders on the register on 15 June 2022 (ex-dividend date 14 June 2022).

The revenue per share earned by the Company during the year was 6.42 pence, which is an increase of 36.6% over the 4.70 pence earned in the prior year, and covers the recommended dividend.

Discount ManagementThe Board believes that investors are best served when the share price trades close to net asset value (“NAV”). The Board recognises that the Company’s share price is affected by the interaction of supply and demand in the market based on investor sentiment towards China and the performance of the NAV per share. The Board has a discount control policy in place whereby it seeks to maintain the discount in single digits in normal market conditions. Subject to market conditions, it will authorise the repurchase of shares with the objective of stabilising the share price discount within a single digit range.

The Company’s discount widened from 1.1% at the start of the reporting year to 7.5% at the end of the reporting year. During the year, the Board authorised the repurchase of 1,506,074 shares into Treasury, representing 0.3% of issued share capital, in its effort to stabilise the discount. These share repurchases have benefited remaining shareholders as the NAV per share has been increased by purchasing shares at a discount. Since the year end and as at the date of this report, the Company has repurchased a further 511,450 ordinary shares into Treasury. No shares have been repurchased for cancellation. The graph in the Annual Report shows the history of the Company’s discount during the year.

At the forthcoming AGM, the Board is seeking to renew the annual authority to repurchase up to 14.99% of the Company’s shares, to be either cancelled or held in Treasury, as it has done each year previously.

Management FeesWith effect from 1 April 2021, the Board agreed a reduced management fee with the Manager, FIL Investment Services (UK) Limited. The revised fee structure is on a tiered basis of 0.90% on the first £1.5 billion of net assets reducing to 0.70% on net assets over £1.5 billion. The variable element of +/-0.20% from the previous fee structure remains unchanged. At the same time, the fixed annual fee of £100,000 for services other than portfolio management has been removed. The revised fee provides savings on the overall percentage costs for shareholders assuming net assets remain constant.

Details of the fee structure for the year ended 31 March 2022 are set out in the Directors’ Report in the Annual Report.

Ongoing ChargeThe Ongoing Charge for the year was 0.94% (2021: 0.97%). As indicated, the Manager is entitled to earn up to an additional 0.20% of NAV per annum if performance is ahead of benchmark over a three-year basis, calculated on a daily basis. Notwithstanding the underperformance against the Benchmark Index in the year, the three year performance has been sufficient to earn the maximum variable element of 0.20%. As a result the Ongoing Charge for the year, including this variable element, was 1.14% (2021: 1.09%).

Board of DirectorsElisabeth Scott, having served on the Board as a non-executive Director since 1 November 2011 and as a Senior Independent Director since 22 July 2016, stepped down from the Board at the conclusion of the AGM on 20 July 2021. She was succeeded as a non-executive Director by Alastair Bruce who was appointed to the Board on 1 July 2021 and she was succeeded as Senior Independent Director by Linda Yueh on 20 July 2021.

As part of the Board’s succession plan, I will retire as Chairman at the AGM on 20 July 2022. Following a formal process, the Board decided that Mike Balfour will succeed me as Chairman at the conclusion of the AGM. As Mike is currently Chairman of the Audit and Risk Committee, Alastair will succeed Mike at the same time.

The Board has appointed Georgina Field as a non-executive Director from 1 July 2022. Her biography is in the Annual Report and she will stand for election at the AGM on 20 July 2022.

In accordance with the UK Corporate Governance Code for Directors of FTSE 350 companies, all Directors, with my exception, are subject to annual re-election at the AGM on 20 July 2022. The Directors’ biographies can be found in the Annual Report, and, between them, they have a wide range of appropriate skills and experience to form a balanced Board for the Company.

Board ApprenticeThe Board continues to participate in the Board Apprentice Scheme arising from a government-supported initiative to give board exposure to aspiring non-executive directors, particularly women and those from ethnic minority backgrounds. Kal Foley-Khalique was appointed as a Board Apprentice on 1 December 2020 for a period of one year. As COVID affected her exposure to the workings of the Board, it was decided to extend her apprenticeship to the AGM on 20 July 2022. She attends all Board and Committee meetings as an observer and it is intended that this will assist her aspirations in securing a non-executive director role in the future. The Board has commenced the process to identify and appoint a new Board Apprentice.

OutlookI shall retire from the board at the forthcoming AGM on 20th July 2022 having served, first as Senior Independent Director and then as Chairman, for the 12 years since our IPO in 2010. Much has changed in China during that time but one thing has not changed. We launched the Company to offer investors with a diversified portfolio the opportunity to have direct exposure to China’s growth; and that approach is now widely accepted. Over the 12 years since the Company launched, the share price total return has been 169.3% compared to a Benchmark Index total return of 81.3%.

Official forecasts in China are that, in the year 2022, growth in GDP will be 5.5% which is greater than the OECD forecast of global growth, although some commentators are questioning whether that rate will be achieved. China is too large and growing too fast to be ignored by investors, especially when that growth is translated into attractively priced earnings for listed companies.

The Company is designed to be a one stop shop for investors’ exposure to China. Dale Nicholls invests in companies of all sizes and has established a record of successfully identifying unlisted companies before they do their own IPO. His emphasis is always to identify those parts of the Chinese economy that are growing fastest and he is supported by a large and experienced team of research analysts on the ground.

ESG has become a prominent issue in recent years although it has always been the case that better governed companies make better investments. Fidelity has used its resources to apply its own ESG ranking methodology which enables the Manager to screen his investments and to engage with companies on their ESG standards.

No doubt the progress of the Company’s share price will continue to experience short-term volatility but we have always portrayed holding shares in the Company as a long term investment.

I have been a shareholder since I joined the board and will continue to be one as I retire; and I look forward to seeing the Company going from strength to strength.

Meanwhile, I hope to see you at our Annual General Meeting in July. Details of the AGM are below.

Nicholas BullChairman30 May 2022

Annual General Meeting – Wednesday, 20 July 2022 at 11.00 amThe AGM of the Company will be held at 11.00 am on Wednesday, 20 July 2022 at 155 Bishopsgate, London EC2M 3YD and virtually via the online Lumi AGM meeting platform. Full details of the meeting are given in the Notice of Meeting in the Annual Report.

Appropriate social distancing and hygiene measures will be in place for those shareholders attending the AGM in person. For those shareholders who would prefer not to attend in person or for whom travel is not convenient, we will live-stream the formal business and presentations of the meeting online.

Dale Nicholls, the Portfolio Manager, will be making a presentation to shareholders highlighting the achievements and challenges of the year past and the prospects for the year to come. He and the Board will be very happy to answer any questions that shareholders may have. Copies of his presentation can be requested by email at investmenttrusts@fil.com or in writing to the Secretary at FIL Investments International, Beech Gate, Millfield Lane, Lower Kingswood, Tadworth, Surrey KT20 6RP.

Properly registered shareholders joining the AGM virtually will be able to vote on the proposed resolutions. Please see Note 8 to the Notes to the Notice of Meeting in the Annual Report for details on how to vote virtually. Investors viewing the AGM online will be able to submit live written questions to the Board and the Portfolio Manager and we will answer as many as possible at an appropriate juncture during the meeting.

Further information and links to the Lumi platform may be found on the Company’s website www.fidelity.co.uk/china. On the day of the AGM, in order to join electronically and ask questions via the Lumi platform, shareholders will need to connect to the website https://web.lumiagm.com.

Please note that investors on platforms such as Fidelity Personal Investing, Hargreaves Lansdown, Interactive Investor or AJ Bell Youinvest will need to request attendance at the AGM in accordance with the policies of your chosen platform. They may request that you submit electronic votes in advance of the meeting. If you are unable to obtain a unique IVC and PIN from your nominee or platform, we will also welcome online participation as a guest. Once you have accessed https://web.lumiagm.com from your web browser on a tablet or computer, you will need to enter the Lumi Meeting ID which is 152-195-444. You should then select the ‘Guest Access’ option before entering your name and who you are representing, if applicable. This will allow you to view the meeting and ask questions but you will not be able to vote.

Portfolio Manager’s Review

Dale Nicholls was appointed as Portfolio Manager of Fidelity China Special Situations PLC on 1 April 2014. He has 27 years of investment experience and also manages the Fidelity Pacific Fund. He spends much of his time speaking to management teams and competitors of companies in which he invests or may choose to invest, engaging with hundreds of companies each year.

QuestionHow has the Company performed in the year under review?

AnswerAs already mentioned in the Chairman’s Statement, a resurgence in COVID cases, fears over China’s slowing growth and increased regulation caused the Company’s Benchmark Index to give up the gains it had made during the previous twelve months, and produced a total return in UK sterling of-29.3%. In this context, the Company’s NAV total return per share, weighed down by the Company’s gearing, fell by 34.9%. During the same period, the share price total return was-39.2% as the discount widened to 7.5% from 1.1% as at the Company’s last year end.

QuestionInvestment performance in the year under review has been challenging, especially compared with the previous year. What have been the main drivers?

AnswerOver the period under review, holdings in industries embroiled in regulatory changes detracted from relative performance. Of note, was the sharp sell-off in Chinese stocks triggered by heightened regulatory changes targeting the education, internet, healthcare and property sectors (related to the “Three Mountains” that need to be scaled to deliver China’s policy of Common Prosperity). Analysing regulatory developments and the direction of travel is naturally a core part of our analysis of the operating environments of companies. While there have clearly been some surprises through this tightening cycle, in areas such as education, we had largely exited from the education sector and so the impact on the Company was not significant. Our impact on the healthcare sector was also limited as we had little exposure to the generics part of the market where we expect the most significant pricing pressure to be. The exposure to the property sector was also limited. The main impact was in the internet related area.

However, the position in carrier-neutral internet data centre (“IDC”) operator VNET Group (previously 21Vianet Group) weighed down returns due to a number of factors including weaker demand from wholesale customers, increased competition, as well as regulatory concerns that have generally applied to US listed Chinese companies. Furthermore, sentiment was dampened by ongoing concerns relating to the pending share sale by Tuspark (a strategic shareholder) due to its debt restructuring. Whilst capacity addition expectations have been lowered, growth remains solid and valuations have fallen to extreme levels, with the stock trading at a significant discount to its net asset value. More broadly speaking, IDC demand remains a structural growth story in China driven by increasing data usage of the internet via mobile devices on the consumer side and increasing demand for cloud and IT services on the enterprise side and I believe VNET is well positioned to benefit from this growth.

Given headwinds such as COVID lockdowns and a weakening property market, it is no surprise that consumption-driven sectors have struggled to perform. This in turn has seen increased pressures on the large internet platforms that have been impacted by lower advertising spend. The regulatory impact on sectors such as education has also clearly played a part here.

As often happens in market downturns, some of the smaller holdings in the Company’s portfolio with less liquidity have suffered more. Tencent-backed livestreaming platform Kuaishou Technology remained out of favour as leading social media and gaming companies faced higher regulatory scrutiny over user data collection and usage. Kuaishou is one of the most popular social platforms in China and one of the few internet companies that continues to have robust growth in users and time-spent-online. The company has undergone some major organisational restructuring which should lead to better operating efficiency over the mid-term. The company’s monetisation of the platform is expected to increase as it shifts its focus to commercial activities, with advertising and e-commerce being two of its biggest growth opportunities.

The holding in online marketing technology company iClick Interactive Asia Group, e-commerce service provider Baozun and supply chain finance technology solution provider Linklogis were caught in the broader market sell-off. The weaker consumer and related advertising spend clearly weighed on iClick and Baozun, as did US delisting fears. The long-term growth story for Baozun remains intact in light of rising online penetration and category expansion including luxury and fast-moving consumer goods (FMCG). The company’s close relationship with Alibaba and large client resources also enables it to get the best resources from Alibaba. In addition, the volume of customers it serves on other platforms, including the fast growing live-streaming platforms, continues to grow. Even factoring in the headwinds, these companies’ shares look significantly oversold and are trading at significant discounts to where we see fair value.

On a positive note, an exposure to SenseTime, which we bought in 2018 while it was unlisted, added notable value as shares in the artificial intelligence (“AI”) technology company rallied following its initial public offering (IPO). The company continues to capitalise on its lead in algorithm production efficiency and in its commercialisation in comparison to other AI start-ups, along with access to a large addressable market backed by strong capabilities in core areas such as computer vision.

The holding in one of our other unlisted investments, autonomous vehicle technology company Pony.ai, also performed well as subsequent investment rounds were announced at significantly higher than expected valuations (the company is also backed by Toyota). The company’s plans of commercialising autonomous driving for all vehicle sizes remain on track and we are closely monitoring its operations regarding both ride-sharing and delivery service networks. It already operates taxi fleets in cities such as Beijing, and I believe the company remains well-positioned as a leading player in this new and emerging market.

Elsewhere, a leading manufacturer of gas equipment and liquid tanks CIMC Enric continues to benefit from solid gas demand growth trends in China over the mid-term, with the shift away from more harmful fossil fuels. As a leader in the business for gas related equipment, the company is well placed to play a role in the innovation required for China to reach its environmental goals. The company is also well positioned in China’s nascent hydrogen supply chain.

QuestionCOVID cases in China are rising again. Is China likely to continue with its zero-COVID policy and what are the implications for the Company’s portfolio?

ANSWERSlowing economic growth - notably slowing consumer activity highlighted in data points such as retail sales - has been exacerbated by the recent COVID lockdowns that we have seen in large cities such as Shanghai. The feedback from consumer related businesses in the region indicate that the impact will be significant in the short-term. Despite the severity of these lockdowns, and while the direction of policy is not always easy to predict, I do believe that we will see a shift towards a loosening of restrictions relatively soon. I believe that recent commentary from certain officials, the approval of foreign antiviral drugs, as well as the evident social strain the policy is having, are all factors that support this view.

There is also a clear impact on supply chains. We are already seeing impact of the recent lockdowns in Shenzhen given the huge productive capacity that was affected there; limits of ports in places like Shanghai are also clearly having a major impact. In terms of implications for the portfolio, as there is a focus on domestic consumption, we are focused on ensuring the fundamentals (such as earnings visibility) of companies we own in the portfolio remain intact.

I do not think that we should underestimate the risks from the zero-COVID policy and I expect the short-term outlook for the consumer sector will be difficult; and this is partly reflected in the portfolio’s current underweight to consumer discretionary positions. However, I remain positive on the long-term potential of the Chinese consumption theme and believe that there is good potential for the unleashing of spending power as the country comes out of the pandemic.

QuestionThe US has indicated it will delist some Chinese companies from its exchanges – have any of your investments been directly impacted, and will the trend continue?

AnswerWhile there are liquidity perspectives to consider, I believe this will clearly improve over time and the vast majority of Chinese companies have the capacity to be listed in other markets such as Hong Kong. Most crucial for me is the underlying value of a company, and not where that company is listed. With this in mind, I have been adding to positions over this period, given the opportunities created by some of the sell-offs which took some stock valuations to extreme levels, presenting attractive opportunities. Examples include VNET, Autohome and Lufax.

QuestionThere has been a lot of talk about how Russia’s invasion of Ukraine will affect Chinese relations with the West and China’s markets – is this of concern?

AnswerGeopolitics is definitely something we all need to be mindful of. Some of the significant economic concerns we held prior to the Russia and Ukraine conflict have indeed been accentuated by the crisis. For example, there is now a greater risk of global stagflation – with greater risks to growth, and ongoing supply chain disruptions increasing costs for everyone.

It seems likely that China will continue its more ‘neutral’ stance towards the conflict, in keeping with the policy actions taken by other large countries in Emerging Markets. The base case would be that we do not see a further deterioration in what is already a strained relationship with the US. While geopolitics often dominates headline news, what I concentrate and focus on is the potential direct impact this can have on the companies I invest in and their earnings, which in most cases, is negligible.

As in previous years, the sales of the companies in which we invest are predominantly domestic. Of the overall portfolio, sales exposure to China is over 90%.

Regarding cost pressures, while these trends and their short-term impact on earnings need to be monitored, we are very focused on companies that have pricing power that will allow them to pass on these costs over time.

QuestionAre people in China domestically experiencing inflation in the same way as in the West and across Europe?

AnswerInflationary pressures in China have been relatively benign and less of a risk compared to trends seen in many Developed Markets. China’s headline Consumer Prices Index (“CPI”) inflation has maintained relatively moderate levels in the past few months and we will need to watch how this trend evolves. Although the year-on-year CPI could be pushed up by higher-than-normal vegetable prices due to weather conditions and COVID restrictions (which have already been partially offset by widening pork deflation), as well as rising fuel costs due to geopolitical tensions on the supply side, we expect such increases to be moderate as Chinese consumer demand remains weak and domestic supply chain disruptions lessen over time. However, this does need to be monitored given volatile commodity prices.

In contrast, the headline CPI inflation in major Developed Market (“DM”) economies hit decade highs in early 2022. The divergence is partially technical, reflecting relatively high weights of pork but low weights of fuels, as highly regulated prices in China somewhat shield inflationary pressures from the global spike in oil prices. In addition, the difference in labour markets may also contribute to the divergence. Service inflation in China was still muted with the labour market deteriorating due to the zero-COVID Policy and tightened restrictions, while the elevated inflation in DM economies like the US had broadened from goods to services with tight labour markets driving strong wage growth.

QuestionThere is obviously a lot of macro uncertainty at the moment, which has led to volatility. What does that mean for valuations? Are there reasons to be optimistic?

AnswerThe graphs in the Annual Report show the extent of the de-rating that we have experienced in the Chinese markets in the last year. Valuations in China, both on a historical basis and compared to global peers, have become increasingly more attractive. Given the concerns discussed, investor sentiment remains quite negative.

I believe there is good potential for less “negative news” going forward. One key factor will be developments in the property sector – a sector whose correction has also been a major drag on the country’s economy from late 2021. At this point, we are already seeing signs of easing measures from purchasing restrictions being lifted to easing mortgage lending in certain cities. I believe this has good potential to continue and expand.

The regulatory wave has good potential to ebb, with a shift more on the implementation of announced policies versus policy surprises. A key example of this is the government’s messaging at the end of April after their Politburo meeting where it was indicated that policy would shift to support economic growth via increased infrastructure spending, more supportive property measures (albeit the policy that housing is for ‘living not speculating’ remains) and the healthy development of internet platforms in order to help underpin consumption and enable pent up demand and spending once lockdowns are lifted.

Finally, I feel we can expect more actions to be taken on both the monetary and fiscal side to support economic growth. This contrasts significantly with the monetary tightening we are seeing in other markets such as the US. These levers, combined with easier comparisons relative to the slowdown from the first half of 2021, have considerable scope to drive faster earnings growth in the market from the second half of 2022.

QuestionIn which companies and sectors are you finding the most exciting opportunities?

AnswerIn terms of opportunities and ideas, the Company remains focused on stocks and sectors that appear well positioned to benefit from China’s long-term structural growth drivers. Indeed, despite recent uncertainties, powerful trends like the expansion of the middle class provide a long runway for growth.

Following the significant recent falls in technology-related names, we feel that the risk/reward pay-off has tipped much more in our favour in these companies. For example, Alibaba Group Holding, factoring out the value of cash and investments, is trading at a single digit price/earnings ratio. Although it does face some competitive challenges, it remains the dominant platform in China and generates very high returns on capital. As is often the case with broad-based corrections, some stocks with lower regulatory risk have also sold-off, presenting some very appealing investment opportunities. Interestingly, this includes some smaller companies that could actually be beneficiaries of regulatory changes since many of the new reforms focus more on larger companies.

We have also moved to build-up a sizeable position in industrials which now stands as the largest sector overweight position in the Company. The core thesis around industry consolidation remains very much in place as areas such as building materials in China are very fragmented relative to what one sees in the more mature markets. Some of the Company’s paint holdings, for example, have underperformed due to property sector concerns and raw materials cost pressure, but I maintain a high level of conviction in the long-term story and see significant potential for future upside as sentiment and fundamentals start to improve. For many of these companies, the exposure to residential property is relatively low and any direct impacts are well managed. Additionally, they should benefit from increased infrastructure investment which I think is likely.

Elsewhere, within financials, I continue to favour insurers, given the industry’s structural growth prospects driven by the country’s demographic trends and rising incomes, particularly for protection-type life insurance products given relatively low levels of penetration. Thus, the portfolio continues to hold an exposure to China Life and China’s third largest insurance group China Pacific Insurance Group (“CPIC”), which covers life as well as property and casualty segments. Both companies are very attractively valued in both absolute terms, versus peer and versus their historic levels. CPIC will implement its so-called “long-journey” reform in 2022, with more focus on productivity and persistency. I am still cautious on mainstream banks in general, but I built a new position in China’s fifth largest state-owned bank, Postal Savings Bank of China. The relatively new management team is focused on leveraging a strong branch network to grow in retail and small to medium enterprise (SME) lending. Its wealth management division is also rapidly ramping up and offers outstanding growth potential. ESG factors are also important – as highlighted below. This all comes at a very attractive valuation.

Another new position was initiated in a leading digital textile printer maker – Hangzhou Honghua Digital Technology. The company’s position is supported by evolving industry trends including increasing the need to shorten production and delivery times, reduction of production batches and rising demand for individualised products. In addition, digital textile printing offers profound environmental benefits in the form of low emissions, wastewater production, energy consumption and waste-material production. Thus, demand push in the form of government policy adoption of digital textile printing also supports what is a long runway for growth. In addition to the building materials examples discussed above, this is a good example of the emergence of companies I would put in the “quality industrial” category. These companies are building real competitive advantages through strong investment in R&D; many of them are seeing strong market share gains, in many cases replacing foreign imports which have dominated these categories.

I also purchased a new holding in China’s second largest pipe company by market share, Yonggao. The company is expected to continue posting solid topline growth amid market consolidation as it continues to take market share from smaller players. The company is building up its distribution channels, warehouses and optimising product flow in weak regions in an effort to improve its utilisation and efficiency. The company also trades at a significant discount to the market and peers.

Within healthcare, I purchased a new position in Zhaoke Ophthalmology, a biotech company focused on ophthalmological products. The company has a comprehensive ophthalmic drug pipeline which is expected to benefit from what is currently an under penetrated market. China’s aging population and increasing use of IT products leads to an increasing prevalence of eye diseases. As such, increasing disease awareness and affordability of treatment coupled with technological advancement for treatment supports strong industry growth trends.

QuestionWhat is your approach to gearing in the Company’s portfolio?

AnswerWhilst the period under review has seen a sell-off in Chinese equities, given current undemanding valuations and the expected tailwind of policy response, I remain increasingly positive and this is reflected in current gearing levels. Towards the end of the period, net gearing was increased to current levels of around 24%. This is due to a combination of adding to areas where we see significant value and closing the majority of our short positions in the wake of the market corrections.

QuestionWhat is your approach to ESG? How do corporates in China address ESG issues, and does this differ from Western markets?

AnswerOur analyst survey, which is based on the findings of engagements with companies, shows that Chinese companies are embracing ESG challenges. As highlighted previously, improvements are often coming from low bases but the pace of improvement is impressive, and this is the most important thing.

In 2021, both the Shanghai and the Shenzhen bourses revised their listing rules which now include a provision for companies to publish a corporate social responsibility (CSR) report (albeit non-mandatory). China also saw progress in ESG ratings overall, specifically, companies with a BBB or above rating in the MSCI Index increasing when compared to 2020, together with the successful inclusion of a carbon footprint for most companies. In addition, there were a number of developments relating to climate change from the government and regulators. The most notable one is the launch of the national carbon trading market in July 2021 which covers 40% of China’s emissions and around 10% of global total emissions.

In recent years, I have witnessed a notable increased focus on ESG from investee companies. I have found separate ESG focused engagement sessions to be incredibly valuable as these have been comprehensive “deep-dives” into understanding a company’s ESG mindset, strategy and capabilities. It is also encouraging that investee companies seek Fidelity’s advice on how to better represent and report on their credentials in this area.

An interesting area of development that we have been monitoring closely is that of green financing. Two companies that are making strong advancements in the financials space are Lufax Holding and Postal Savings Bank of China. We have engaged with both companies extensively. Lufax differentiates itself by targeting small business owners underserved by the country’s banks by providing them with large ticket-size/long tenor funding. It was encouraging to see the company release its first ESG report last year, committing to adhere to the nation’s guidelines on green finance and inclusive finance by executing their mission of providing inclusive and compassionate financial services.

Postal Savings Bank of China (“PSBC”) was upgraded by MSCI from BBB to A in November 2021, mainly due to the bank’s strong ESG incorporation in both its business practices and its rapid expansion in green loans. PSBC’s targeted agricultural loans and green loans are more resilient through cycles which enables it to post superior loan growth. Aside from over 30% growth in green loans, PSBC set up its A-Share ESG Index on the Deutsche Boerse over the past year, to promote ESG investment into A-Share companies from a global perspective. The bank also facilitated over 450 corporate customers in conducting their carbon accounting last year.

In the Annual Report, are two examples of our company engagements. Zhejiang Weixing which has a good ESG rating but we engaged with to improve further and Lenovo Group which has excellent practices on gender diversity.

The chart in the Annual Report demonstrates that the Company’s portfolio has a significantly lower carbon footprint than that of the Benchmark Index.

QuestionHow much of the portfolio is made up of unlisted investments and how do you feel about these holdings?

AnswerThe portfolio’s unlisted positions span a wide range of industries and collectively account for 13.2% of the overall portfolio. These holdings represent some of the most interesting companies in the world. For example, ByteDance, the internet technology company, remains a major holding in this space and the company continues to deliver very strong revenue and profit growth through Douyin in China and TikTok internationally.

However, investing in pre-IPO companies is not without complication as recent experience with ride hailing company Xiaoju Kuaizhi (Didi Chuxing) has reminded us. Didi remains under investigation by the Cyberspace Administration of China (CAC) and is on a path to delist from US Exchanges. This has led to a significant decline in the value of its shares post IPO. Even after taking into account the uncertainty around these factors, I believe Didi’s shares look oversold given its still dominant market position.

Investing in this space is a key differentiating factor for the Company and while it takes some time to find the right opportunities, on balance, it is clear to me that these efforts are worthwhile. We seek to capitalise on the widest set of investment opportunities in China. The fact that world leading companies such as ByteDance and DJI International, are still private, illustrates the importance of looking beyond the listed universe. Notably, two of the unlisted positions – HR management software provider Beisen and auto maintenance platform Tuhu Car – have applied for listings in Hong Kong.

Further details of the Company’s unlisted investments are in the Annual Report.

QuestionCan you explain your choice of your five largest holdings?

AnswerEach of my top five holdings are at least 2.5% of the Company’s asset exposure and comprise 29% in total in the portfolio. Generally, this is justified by their strong risk/reward characteristics – scoring well on the core framework by factoring in growth, returns, management and valuations. Below are details of the five holdings.

Tencent Holdings – Tencent’s monopolistic position in social networking in China and the attendant benefits of powerful network effects are reasons why this is my largest holding. Tencent has carefully nurtured and enriched the user experience and benefits from a sizeable user base. As China’s internet user growth slows down, Tencent’s enviable user base gives it a strong competitive advantage. The entire internet industry focus has shifted towards monetisation and Tencent’s position in such an environment remains favourable given its highly loyal user base and strong ecosystem. Tencent remains highly competitive in its core business despite the recent regulatory and macro headwinds. We also expect that the recent resumption in game approvals will eventually extend to games published by Tencent. Valuations are now much more compelling versus both history and peers given the market’s recent correction.

Alibaba Group Holding – Alibaba holds a dominant position in the e-commerce market. The company has built a comprehensive ecosystem that has superior breadth and depth and is the foundation of its loyal merchants and consumers base, which ultimately supports its pricing power. Furthermore, the company is nurtured in an environment of continuous innovation, customer focus and pursuit of excellence which has enabled it to expand beyond its comfort zone and increase the addressable market.

Weak consumption trends and rising competition in e-commerce raise downside risk. Nevertheless, the company’s clear refocus and reprioritisation in its businesses will aid growth. The company’s China commerce division will be focusing on optimising returns whereas its cloud and international business will focus on growth. While we still await regulatory clarity around areas like the Ant financial business, in general regulatory risks are likely close to or past peak in my view. Similar to Tencent or even more so, Alibaba’s valuations are very compelling versus history and peers.

WuXi AppTec – The company is a long-term beneficiary from increasing pharmaceutical and biotech contract research and manufacturing (CDMO/CMO) demand globally. China’s CDMO/CMO business has significant investment potential, supported by a structural shift from generic to innovative drugs in the country’s pharmaceutical market. WuXi has established a talent pool with strong technical skills, which has helped drive a loyal client base. It is well positioned to deliver solid earnings growth broadly supported by its WuXi Chemistry business. Looking ahead, there is exciting potential upside from growing areas such as cell/gene therapy.

Pony.ai – The Toyota backed autonomous vehicle technology company presents significant growth potential as a market leader in an emerging new industry that will transform traditional ways of transportation. The company plans to commercialise autonomous driving for all sizes of vehicles and to operate on both ridesharing and delivery service networks.

SenseTime – The company is a leading artificial intelligence (“AI”) technology company specialising in computer vision. The company has access to a large addressable market backed by strong algorithm capabilities. It has a leading market position in its four key business lines and serves a wide range of industries across commercial space management, urban management, manufacturing, transportation, automobiles, etc. SenseTime is a prime example of a research-oriented company and its culture is deeply rooted in academic excellence. SenseTime was purchased on 7 June 2018 and had its IPO on 6 December 2021 with an uplift of 18.5% per annum. However, our shareholding post IPO has been subject to a 180 day lock-up period.

QuestionDoes the long-term case for investing in China remain strong?

AnswerDespite recent challenges and ongoing uncertainty, we remain positive on the long-term investment opportunities on offer in China. We believe a lot of the negative news flow is reflected in current valuations, which look very attractive relative to other markets and to China’s own history. As discussed above, we are seeing increased messaging from authorities around measures to support growth and address challenges such as those posed by the property market slowdown. Our ongoing analysis highlights that we should be past the worst of the regulatory headwinds we experienced during 2021. Adding to this is the likely looser policy stance which is in direct contrast to what we are seeing across other major economies - this backdrop supports the case for China to outperform on a relative basis moving forward.

Finally, investor sentiment towards China has been very weak and therefore any alleviation of the factors depressing sentiment could be the catalyst for a share price recovery. The combination of weak sentiment and low valuations has created a number of opportunities and we continue to put money to work in areas where we see long-term value. This is reflected in the increased gearing in the portfolio which stood at 124% at the time of writing, and is a relatively high level versus history. I have also increased my personal holding in the Company to 113,042 shares.

Dale NichollsPortfolio Manager30 May 2022

Principal Risks and Uncertainties and Risk ManagementAs required by provisions 28 and 29 of the 2018 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, including those that could threaten its business model, future performance, solvency or liquidity. The Board, with the assistance of the Alternative Investment Fund Manager (FIL Investment Services (UK) Limited/the “Manager”), has developed a risk matrix which, as part of the risk management and internal controls process, identifies the key existing and emerging risks and uncertainties that the Company faces. The Audit and Risk Committee continues to identify any new emerging risks and take any action necessary to mitigate their potential impact. The risks identified are placed on the Company’s risk matrix and graded appropriately. This process, together with the policies and procedures for the mitigation of existing and emerging risks, is updated and reviewed regularly in the form of comprehensive reports considered by the Audit and Risk Committee. The Board determines the nature and extent of any risks it is willing to take in order to achieve its strategic objectives.

The Manager also has responsibility for risk management for the Company. It works with the Board to identify and manage the principal and emerging risks and uncertainties and to ensure that the Board can continue to meet its UK corporate governance obligations.

A key emerging issue that the Board has identified is climate change. It is one of the most critical emerging issues confronting asset managers and their investors. The Board notes that the Manager has integrated ESG considerations, including climate change, into the Company’s investment process. Further details are in the Annual Report. The Board will continue to monitor how this may impact the Company as a risk, the main risk being the impact on investment valuations. Another emerging risk that the Board has identified is regulatory risk and the ability of China’s centralised goverment to enact regulation swiftly that may impact the stock markets negatively and its knock on impact on the Company’s portfolio and net asset value.

The Board considers the following as the principal risks and uncertainties faced by the Company.

Other risks facing the Company include:

Tax and Regulatory RisksThere is a risk of the Company not complying with the tax and regulatory requirements in the UK and China. 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 monitors tax and regulatory changes at each Board meeting and through active engagement with regulators and trade bodies by the Manager.

Operational RisksThe Company relies on a number of third party service providers, principally the Manager, Registrar, Custodian and Depositary. It is dependent on the effective operation of the Manager’s 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. The Registrar, Custodian and Depositary are all subject to a risk-based programme of internal audits by the Manager. In addition, service providers’ own internal control reports are received by the Board on an annual basis and any concerns are investigated. Risks associated with these service providers is rated as low, but the financial consequences could be serious, including reputational damage to the Company.

Viability StatementIn accordance with provision 31 of the 2018 UK Corporate Governance Code, the Directors have assessed the prospects of the Company over a longer period than the twelve month period required by the “Going Concern” basis. The Company is an investment trust with the objective of achieving long-term capital growth. The Board considers long-term to be at least five years, and accordingly, the Directors believe that 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 Company’s level of gearing;

· The Company’s NAV and share price performance;

· The principal and emerging risks and uncertainties facing the Company as set out above and their potential impact;

· The future demand for the Company’s shares;

· The Company’s share price 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 for the five year reporting period to 31 March 2022 is well ahead of the Benchmark Index, with a NAV total return of 28.9%, a share price total return of 38.3% compared to the Benchmark Index total return of 12.9%. The Board regularly reviews the investment policy and considers whether it remains appropriate. The Board has 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 based on the following considerations:

· The Investment Manager’s compliance with the Company’s investment objective and policy, its investment strategy and asset allocation;

· The fact that the portfolio comprises sufficient 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 which are considered to be reasonable in comparison to the Company’s total assets.

In preparing the Financial Statements, the Directors have considered the impact of climate change, particularly in the context of the climate change risk identified within the ESG Risk above. The Board has also considered the impact of regulatory changes and how this may affect the Company.

In addition, the Directors’ assessment of the Company’s ability to operate in the foreseeable future is included in the Going Concern Statement below.

Going Concern StatementThe Financial Statements of the Company have been prepared on a going concern basis.

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 and its expenditure and cash flow projections. The Directors, having considered the liquidity of the Company’s portfolio of investments (being mainly securities which are readily realisable), the projected income and expenditure and the loan facility agreement, are satisfied that the Company is financially sound and has adequate resources to meet all of its liabilities and ongoing expenses and continue in operational existence for the foreseeable future. The Board has therefore concluded that the Company has adequate resources to continue to adopt the going concern basis for the period to 31 May 2023 which is at least twelve months from the date of approval of the Financial Statements. This conclusion also takes into account the Board’s assessment of the ongoing risks from COVID as set out in the Business Continuity Risk above. The prospects of the Company over a period longer than twelve months can be found in the Viability Statement above.

PROMOTING THE SUCCESS OF THE COMPANYUnder Section 172(1) of the Companies Act 2006, the Directors of a company must act in a way they consider, in good faith, would be most likely to promote the success of the Company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to the likely consequences of any decision in the long-term; the need to foster relationships with the Company’s suppliers, customers and others; the impact of the Company’s operations on the community and the environment; the desirability of the Company maintaining a reputation for high standards of business conduct; and the need to act fairly as between members of the company.

As an externally managed Investment Trust, the Company has no employees or physical assets, and a number of the Company’s functions are outsourced to third parties. The key outsourced function is the provision of investment management services by the Manager, but other professional service providers support the Company by providing administration, custodial, banking and audit services. The Board considers the Company’s key stakeholders to be the existing and potential shareholders, the external appointed Manager (Fidelity), the providers of debt facilities and other third party professional service providers. The Board considers that the interest of these stakeholders is aligned with the Company’s objective of delivering long-term capital growth to investors, in line with the Company’s stated investment objective and strategy, while providing the highest standards of legal, regulatory and commercial conduct.

The Board, with the Portfolio Manager, sets the overall investment strategy and reviews this at an annual strategy day which is separate from the regular cycle of board meetings. In order to ensure good governance of the Company, the Board has set various limits on the investments in the portfolio, whether in the maximum size of individual holdings, the use of derivatives, the level of gearing and others. These limits and guidelines are regularly monitored and reviewed and are set out in the Annual Report.

The Board places great importance on communication with shareholders. The Annual General Meeting provides the key forum for the Board and the Portfolio Manager to present to the shareholders on the Company’s performance and future plans and the Board encourages all shareholders to attend in person or virtually, and raise questions and concerns. The Chairman and other Board members are available to meet shareholders as appropriate. Shareholders may also communicate with Board members at any time by writing to them at the Company’s registered office at FIL Investments International, Beech Gate, Millfield Lane, Tadworth, Surrey KT20 6RP or via the Company Secretary in writing at the same address or by email at investmenttrusts@fil.com. The Portfolio Manager meets with major shareholders, potential investors, stock market analysts, journalists and other commentators during the year. These communication opportunities help inform the Board in considering how best to promote the success of the company over the long-term.

The Board seeks to engage with the Manager and other service providers and advisers in a constructive and collaborative way, promoting a culture of strong governance, while encouraging open and constructive debate, in order to ensure appropriate and regular challenge and evaluation. This aims to enhance service levels and strengthen relationships with service providers, with a view to ensuring shareholders’ interests are best served, by maintaining the highest standards of commercial conduct while keeping cost levels competitive.

Whilst the Company’s direct operations are limited, the Board recognises the importance of considering the impact of the Company’s investment strategy on the wider community and environment. The Board believes that a proper consideration of Environmental, Social and Governance (“ESG”) issues aligns with the investment objective to deliver long-term capital growth, and the Board’s review of the Manager includes an assessment of their ESG approach, which is set out in detail in the Annual Report.

In addition to ensuring that the Company’s investment objective was being pursued, key decisions and actions taken by the Directors during the reporting year, and up to the date of this report, have included:

· Seeking shareholder approval at the AGM on 20 July 2021 to change the Investment Policy to increase the unlisted securities limit from 10% to 15% of Net Assets plus Borrowings in order to recognise the growing importance of unlisted investments within the Company;

· As a result of the above change in the limit on unlisted investments, seeking shareholder approval at the AGM on 20 July 2021 to amend the Company’s Investment Objective to give more clarity;

· Authorising the repurchase of 1,506,074 ordinary shares when the Company’s discount widened, in line with the Board’s intention that the ordinary share price should trade at a level close to the underlying NAV;

· The decision to pay a final dividend of 5.50 pence per ordinary share, the highest rate since the Company was launched; and

· As part of the Board’s succession plan, the appointment of Georgina Field to the Board with effect from 1 July 2022.

Statement of Directors’ Responsibilities

The Directors are responsible for preparing the Annual Report and the Financial Statements in accordance with applicable United Kingdom 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 UK-adopted International Accounting Standards (“IFRS”) in conformity with the requirements of the Companies Act 2006 and IFRIC interpretations. Under company law the Directors must not approve the Financial Statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss for the reporting period.

In preparing these Financial Statements the Directors are required to:

· select suitable accounting policies in accordance with IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors, and then apply them consistently;

· make judgements and estimates that are reasonable and prudent;

· present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information;

· provide additional disclosures when compliance with the specific requirements in IFRS is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the Company’s financial position and financial performance;

· state whether applicable IFRS and IFRIC interpretations have been followed, subject to any material departures disclosed and explained in the Financial Statements; and

· prepare the Financial Statements on the going concern basis unless it is inappropriate to assume that the Company will continue in business.

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 to the Manager the 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.fidelity.co.uk/china. 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 own jurisdictions.

The Directors confirm that to the best of their knowledge:

· The Financial Statements, prepared in accordance with UK-adopted International Accounting Standards (“IFRS”) in conformity with the requirements of the Companies Act 2006 and IFRIC interpretations, give a true and fair view of the assets, liabilities, financial position and profit of the Company; and

· The Annual Report includes 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.

The Directors consider that the Annual Report and Financial Statements, taken as a whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the Company’s performance, business model and strategy.

Approved by the Board on 30 May 2022 and signed on its behalf by:

NICHOLAS BULLChairman

FINANCIAL STATEMENTS

Income Statement for the year ended 31 March 2022

The Company does not have any income or expenses that are not included in the profit/(loss) after taxation for the year. Accordingly the 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. 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 the profit/(loss) 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 below form an integral part of these Financial Statements.

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MARCH 2022

The Notes below form an integral part of these Financial Statements.

BALANCE SHEET AS AT 31 MARCH 2022Company number 7133583

The Financial Statements above and below were approved by the Board of Directors on 30 May 2022 and were signed on its behalf by:

NICHOLAS BULLChairman

The Notes below form an integral part of these Financial Statements.

CASH FLOW STATEMENT FOR THE YEAR ENDED 31 MARCH 2022

The Notes below form an integral part of these Financial Statements.

NOTES TO THE FINANCIAL STATEMENTS

1 PRINCIPAL ACTIVITYFidelity 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 POLICIESThe Company’s Financial Statements have been prepared in accordance with UK-adopted International Accounting Standards (“IFRS”) in conformity with the requirements of the Companies Act 2006, IFRIC 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 (“SORP”) issued by the Association of Investment Companies (“AIC”) in April 2021. 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 instruments. The Directors have a reasonable expectation that the Company has adequate resources to continue in operational existence up to 31 May 2023 which is at least twelve months from the date of approval of these Financial Statements. In making their assessment the Directors have reviewed income and expense projections, reviewed the liquidity of the investment portfolio and considered the Company’s ability to meet liabilities as they fall due. This conclusion also takes into account the Director’s assessment of the continuing risks arising from COVID-19.

In preparing these Financial Statements the Directors have considered the impact of climate change risk as a principal and as an emerging risk as set out above, and have concluded that there was no further impact of climate change to be taken into account as the investments are valued based on market pricing. In line with IFRS13 investments are valued at fair value, which for the Company are quoted bid prices for investments in active markets at the balance sheet date. Investments which are unlisted are priced using market-based valuation approaches. All investments therefore reflect the market participants view of climate change risk on the investments held by the Company.

The Company’s Going Concern Statement above takes account of all events and conditions up to 31 May 2023 which is at least twelve months from the date of approval of these Financial Statements.

b) Adoption of new and revised International Financial Reporting Standards – the accounting policies adopted are consistent with those of the previous financial year, other than those stated below. Their adoption has not had any material impact on the disclosures or the amounts reported in these Financial Statements.

· COVID-19-Related Rent Concessions (amendments to IFRS 16); and

· Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16 – interest rate benchmark reform – Phase 2.

At the date of authorisation of these Financial Statements, the following revised IAS were in issue but not yet effective:

· IAS 1 Presentation of Financial Statements (amendments);

· IAS 8 Accounting Policies, Changes in Accounting estimates and errors (amendments); and

· IAS 12 Income Taxes (amendments).

The Directors do not expect that the adoption of the above Standards will have a material impact on the Financial Statements of the Company in future periods.

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 revenue profit after taxation for the year 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, assumptions and judgements – The preparation of the Financial Statements requires the use of estimates, assumptions and judgements. These estimates, assumptions and judgements affect the reported amounts of assets and liabilities at the reporting date. While estimates are based on best judgement using information and financial data available, the actual outcome may differ from theses estimates.

The key sources of estimation and uncertainty relate to the fair value of the unlisted investments.

JudgementsThe Directors consider whether each fair value is appropriate following detailed review and challenge of the pricing methodology. The judgement applied in the selection of the methodology used (see Note 2 (l) below) for determining the fair value of each unlisted investment can have a significant impact upon the valuation.

EstimatesThe key estimate in the Financial Statements is the determination of the fair value of the unlisted investments by the Manager’s Fair Value Committee (“FVC”), with support from the external valuer, for detailed review and appropriate challenge by the Directors. This estimate is key as it significantly impacts the valuation of the unlisted investments at the Balance Sheet date. When no recent primary or secondary transaction in the company’s shares have taken place, the fair valuation process involves estimation using subjective inputs that are unobservable (for which market data is unavailable). The estimates involved in the valuation process may include the following:

(i) the selection of appropriate comparable companies. Comparable companies are chosen on the basis of their business characteristics and growth patterns;

(ii) the selection of a revenue metric (either historical or forecast);

(iii) the selection of an appropriate illiquidity discount factor to reflect the reduced liquidity of unlisted companies versus their listed peers;

(iv) the estimation of the likelihood of a future exit of the position through an initial public offering (“IPO”) or a company sale;

(v) the selection of an appropriate industry benchmark index to assist with the valuation; and

(vi) the calculation of valuation adjustments derived from milestone analysis and future cash flows (i.e. incorporating operational success against the plans/forecasts of the business into the valuation).

As the valuation outcomes may differ from the fair value estimates a price sensitivity analysis is provided in Other Price Risk Sensitivity in Note 19 below to illustrate the effect on the Financial Statements of an over or under estimation of fair value.

The risk of an over or under estimation of fair value is greater when methodologies are applied using more subjective inputs.

AssumptionsThe determination of fair value by the FVC involves key assumptions dependent upon the valuation techniques used. The valuation process recognises that the price of a recent investment may be an appropriate starting point for estimating fair value. The Multiples approach involves subjective inputs and therefore presents a greater risk of over or under estimation, particularly in the absence of a recent transaction.

f) Income – Income from equity investments and long contracts for difference (“CFDs”) 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. Overseas dividends are accounted for gross of any tax deducted at source. 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 received on CFDs, collateral and bank deposits are accounted for on an accruals basis and credited to the revenue column of the Income Statement. Interest received on CFDs represent the finance costs calculated by reference to the notional value of the CFDs.

g) Functional currency and foreign exchange – The functional and reporting currency of the Company is UK sterling, which is the currency of the primary economic environment in which the Company operates. Transactions denominated in foreign currencies are reported in UK sterling at the rate of exchange ruling at the date of the transaction. Assets and liabilities in foreign currencies are translated at the rates of exchange ruling at the Balance Sheet date. Foreign exchange gains and losses arising on translation are recognised in the Income Statement as a revenue or a capital item depending on the nature of the underlying item to which they relate.

h) Investment management and other expenses – These are accounted for on an accruals basis and are charged as follows:

· The base investment management fee is allocated 25% to revenue and 75% to capital;

· The variable investment management fee is charged/credited to capital as it is based on the performance of the net asset value per share relative to the Benchmark Index; 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 on the bank loan, collateral and overdrafts and finance costs paid on CFDs, which are accounted for on an accruals basis, 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 25% to revenue and 75% to capital.

j) Taxation – The taxation charge 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) Dividend paid to shareholders – Dividends payable to equity shareholders are recognised when the Company’s obligation to make payment is established.

l) Investments – 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. Under IFRS 9 investments are 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 best estimate of fair value. The Manager’s Fair Value Committee (“FVC”), which is independent of the Portfolio Manager’s team, and with support from the external valuer, provides recommended fair values to the Directors. These are based on the principles outlined in Note 2 (e) above. The unlisted investments are valued at fair value following a detailed review and appropriate challenge by the Directors of the pricing methodology used by the FVC.

The techniques applied by the FVC when valuing the unlisted investments are predominantly market-based approaches. The market-based approaches are set out below and are followed by an explanation of how they are applied to the Company’s unlisted portfolio:

· Multiples;

· Industry Valuation Benchmarks; and

· Available Market Prices.

The nature of the unlisted investment will influence the valuation technique applied. The valuation approach recognises that the price of a recent investment, if resulting from an orderly transaction, generally represents fair value as at the transaction date and may be an appropriate starting point for estimating fair value at subsequent measurement dates. However, consideration is given to the facts and circumstances as at the subsequent measurement date, including changes in the market or performance of the investee company. Milestone analysis and future cash flows are used where appropriate to incorporate the operational progress of the investee company into the valuation. Consideration is also given to the input received from the Fidelity International analyst that covers the company and from an external valuer. Additionally, the background to the transaction must be considered. As a result, various multiples-based techniques are employed to assess the valuations particularly in those companies with established revenues. An absence of relevant industry peers may preclude the application of the Industry Valuation Benchmarks technique and an absence of observable prices may preclude the Available Market Prices approach.

The unlisted investments are valued according to a three month cycle of measurement dates. The fair value of the unlisted investments will be reviewed before the next scheduled three monthly measurement date on the following occasions:

· at the year end and half year end of the Company; and

· where there is an indication of a change in fair value (commonly referred to as ‘trigger’ events).

In accordance with the AIC SORP, the Company includes transaction costs, incidental to the purchase or sale of investments within (losses)/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 – 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. Under IFRS 9 derivatives are classified at 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;

· Futures – the difference between contract price and the quoted trade price; and

· Options – the quoted trade price for the contract.

Where such transactions are used to protect or enhance income, if the circumstances support this, 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 (losses)/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 on the Balance Sheet at their fair value within current assets or current liabilities.

The Company obtains equivalent exposure to equities through the use of CFDs. All gains and losses in the fair value of the CFDs are included in (losses)/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 – Cash deposits are held in segregated accounts on behalf of brokers as collateral against open derivative contracts. These are carried at amortised cost.

o) Other receivables – Other receivables include amounts receivable on settlement of derivatives, securities sold for future settlement, accrued income, taxation recoverable and other debtors and prepayments 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. Other receivables are recognised initially at fair value and, where applicable, subsequently measured at amortised cost using the effective interest rate method and as reduced by appropriate allowance for estimated irrecoverable amounts.

p) 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.

q) Other payables – Other payables include amounts payable on settlement of derivatives, securities purchased for future settlement, investment management, secretarial and administration fees payable, loan interest payable, finance costs 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.

r) Other reserve – The full cost of ordinary shares repurchased and held in Treasury is charged to the other reserve.

s) 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;

· Variable investment management fees;

· 75% of base investment management fees;

· 75% of finance costs;

· Dividends receivable which are capital in nature;

· Taxation charged or credited relating to items which are capital in nature: and

· Other expenses which are capital in nature.

Technical guidance issued by the Institute of Chartered Accountants in England and Wales in TECH 02/17BL, guidance on the determination of realised profits and losses in the context of distributions under the Companies Act 2006, states that 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, the portfolio of the Company consisted of investments listed on a recognised stock exchange and were considered to be readily convertible to cash, with the exception of the level 3 investments which had unrealised investment holding gains of £17,794,000 (2021: unrealised investment holding losses of £1,569,000). See Note 19 below for further details on the level 3 investments.

3 INCOME

Special dividends of £nil (2021: £29,083,000) have been recognised in capital.

4 INVESTMENT MANAGEMENT FEES

FIL Investment Services (UK) Limited (a Fidelity group company) is the Company’s Alternative Investment Fund Manager (“the Manager”) and has delegated portfolio management to FIL Investment Management (Hong Kong) Limited (“the Investment Manager”).

From 1 April 2021, the base investment management fee is charged at an annual rate of 0.90% on the first £1.5 billion of net assets, reducing to 0.70% of net assets over £1.5 billion. Prior to this date, the investment management fee was charged at an annual rate of 0.90% of net assets. In addition, there is a +/-0.20% variation fee based on the Company’s NAV per share performance relative to the Company’s Benchmark Index. Fees are payable monthly in arrears and are calculated on a daily basis.

The base investment management fee has been allocated 75% to capital reserve in accordance with the Company's accounting policies.

Further details of the terms of the Management Agreement are given in the Directors’ Report in the Annual Report.

5 OTHER EXPENSES

1 Details of the breakdown of Directors’ fees are provided within the Directors’ Remuneration Report in the Annual Report.

2 From 1 April 2021, the fixed annual fee for services other than portfolio management is no longer charged.

6 FINANCE COSTS

Finance costs have been allocated 75% to capital reserve in accordance with the Company's accounting policies.

7 TAXATION

b) Factors affecting the taxation charge for the yearThe taxation charge for the year is lower than the standard rate of UK corporation tax for an investment trust company of 19% (2021: 19%). A reconciliation of the standard rate of UK corporation tax to the taxation charge for the year is shown below:

* The Company is exempt from UK corporation tax 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 taxationA deferred tax asset of £35,407,000 (2021: £24,593,000), in respect of excess expenses of £141,629,000 (2021: £129,434,000) has not been recognised as it is unlikely that there will be sufficient future taxable profits to utilise these expenses.

In the Spring Budget of 2021, the UK Government announced that from 1 April 2023 the corporation tax rate will increase to 25%. This rate has been substantively enacted at the balance sheet date and has therefore been applied to calculate the unrecognised deferred tax asset for the current year (2021: 19%).

8 EARNINGS/(LOSS) PER ORDINARY SHARE

The earnings/(loss) per ordinary share is based on the profit/(loss) after taxation for the year divided by the weighted average number of ordinary shares held outside Treasury during the year, as shown below:

9 DIVIDENDS PAID TO SHAREHOLDERS

The Directors have proposed the payment of a dividend for the year ended 31 March 2022 of 5.50 pence per ordinary share which is subject to approval by shareholders at the Annual General Meeting on 20 July 2022 and has not been included as a liability in these Financial Statements. The dividend will be paid on 27 July 2022 to shareholders on the register at the close of business on 15 June 2022 (ex-dividend date 14 June 2022).

10 INVESTMENTS AT FAIR VALUE THROUGH PROFIT OR LOSS

* The fair value hierarchy of the investments is shown in Note 19 below.

The Company received £925,998,000 (2021: £1,009,419,000) from investments sold in the year. The book cost of these investments when they were purchased was £799,114,000 (2021: £648,403,000). These investments have been revalued over time and until they were sold any unrealised gains/losses were included in the fair value of the investments.

Investment transaction costs incurred in the acquisition and disposal of investments, which are included in the (losses)/gains on investments were as follows:

The portfolio turnover rate for the year was 45.2% (2021: 59.8%). The portfolio turnover rate measures the Company’s trading activity. It is calculated by taking the average of the total amount of securities purchased and the total amount of securities sold in the reporting year divided by the average fair value of investments.

11 DERIVATIVE INSTRUMENTS

* The fair value hierarchy of the derivative instruments is shown in Note 19 below.

12 OTHER RECEIVABLES

13 BANK LOAN – REPAYABLE WITHIN ONE YEAR

The current loan agreement with Scotiabank Europe PLC is due to be repaid on 14 February 2023 (see Note 15 below).

14 OTHER PAYABLES

15 BANK LOAN – REPAYABLE AFTER MORE THAN ONE YEAR

On 14 February 2020, the Company entered into a three year unsecured loan agreement with Scotiabank Europe PLC. The interest rate is fixed at 2.606% per annum until the agreement terminates on 14 February 2023.

16 SHARE CAPITAL

* The ordinary 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 1,506,074 (2021: 23,345,560) ordinary shares and held them in Treasury. The cost of repurchasing these shares of £4,448,000 (2021: £58,558,000) was charged to the other reserve.

17 CAPITAL AND RESERVES

The capital reserve balance at 31 March 2022 includes investment holding losses on investments of £265,007,000 (2021: gains of £465,708,000) as detailed in Note 10 above. See Note 2 (s) above for further details.The revenue, capital and other reserves are distributable by way of dividend.

18 NET ASSET VALUE PER ORDINARY SHARE

It is the Company's policy that shares held in Treasury will only be reissued at net asset value per share or at a premium to net asset value per share and, therefore, shares held in Treasury have no dilutive effect.

19 FINANCIAL INSTRUMENTSManagement of RiskThe 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 Manager, has developed a risk matrix which, as part of the internal control process, identifies the risks that the Company faces. Principal risks identified are geopolitical, regulatory and capital market, economic (including pandemic), business continuity, investment performance (including gearing), unlisted securities, market and currency, discount (including investor perception of China), environmental, social and governance ("ESG") and climate and people risks. Other risks identified are tax and regulatory 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 above.

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 may comprise:

· Equity shares (listed and unlisted), equity linked notes, convertible bonds and rights issues;

· 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 receivables and payables 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 riskInterest rate risk

The Company finances its operations through its share capital raised. In addition, the Company has derivative instruments and an unsecured fixed rate loan facility for US$100,000,000 expiring on 14 February 2023. The Company has drawn down the whole of this facility as disclosed in Note 13 above.

Interest rate risk exposureThe values of the Company’s financial instruments that are exposed to movements in interest rates are shown below:

Foreign currency riskThe Company’s profit/(loss) after taxation and its net assets can be affected by foreign exchange 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 loan;

· 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 assetsThe Company’s financial assets comprise of investments, long positions on derivative instruments, short-term debtors and cash at bank. The currency exposure profile of these financial assets is shown below:

1 The asset exposure of long CFDs and call options after the netting of hedging exposures.

2 Other receivables include amounts held at futures clearing houses and brokers.

1 The asset exposure of long CFDs after the netting of hedging exposures.

2 Other receivables include amounts held at futures clearing houses and brokers.

Currency exposure of financial liabilitiesThe 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 loan and other payables. The currency profile of these financial liabilities is shown below:

* The asset exposure of short derivative instruments excluding hedging exposures.

Other price riskOther 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 Board meets quarterly to consider the asset allocation of the portfolio and the risk associated with particular industry sectors within the parameters of the investment objective.

The Investment Manager is responsible for actively monitoring the portfolio selected in accordance with the overall asset allocation parameters and seeks to ensure that individual stocks also meet an acceptable risk/reward profile. Other price risks arising from derivative positions, mainly due to the underlying exposures, are assessed by the Investment Manager’s specialist derivative instruments team.

Liquidity riskLiquidity risk is the risk that the Company will encounter difficulties in meeting obligations associated with financial liabilities. The Company’s assets mainly comprise readily realisable securities and derivative instruments which can be sold easily to meet funding commitments if necessary. Short-term flexibility is achieved by the use of a bank overdraft, if required. The Company has the facility to borrow up to US$100,000,000 (2021: US$100,000,000) until 14 February 2023. The current borrowing is shown in Note 13 above.

Counterparty riskCertain 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 and Derivatives Association’s (“ISDA”) market standard derivative legal documentation. These are known as Over The Counter (“OTC”) 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 Manager employs, this risk is minimised by only entering into transactions with counterparties which are believed 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.

CollateralFor OTC and exchange traded 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 2022, £21,395,000 (2021: £15,589,000) was held by the brokers in cash denominated in US dollars in a segregated collateral account, on behalf of the Company, to reduce the credit risk exposure of the Company. This collateral comprised: J.P. Morgan Securities plc £15,836,000 (2021: £2,058,000), Goldman Sachs International Ltd £5,559,000 (2021: £4,153,000), UBS AG £nil (2021: £6,639,000) and Morgan Stanley & Co. International Ltd £nil (2021: £2,739,000). As at 31 March 2022, £32,220,000 (2021: £19,872,000), shown as amounts held at futures clearing houses and brokers on the Balance Sheet, was held by the Company, in a segregated collateral account on behalf of the brokers, to reduce the credit risk exposure of the brokers. The collateral comprised: UBS AG £27,437,000 (2021: £14,117,000) in cash, Morgan Stanley & Co. International Ltd £3,977,000 (2021: £nil) in cash and HSBC Bank plc £806,000 (2021: £5,755,000) in cash.

OffsettingTo mitigate counterparty risk for OTC derivative transactions, the ISDA legal documentation is in the form of a master agreement between the Company and the broker. This allows enforceable netting arrangements in the event of a default or termination event. Derivative instrument assets and liabilities that are subject to netting arrangements have not been offset in preparing the Balance Sheet.

The Company’s derivative instrument financial assets and liabilities recognised in the Balance Sheet and amounts that could be subject to netting in the event of a default or termination are shown below:

Credit riskFinancial 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 Manager 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 Manager. Exposure to credit risk arises on outstanding security transactions and derivative instrument contracts and cash at bank.

Derivative instrument riskA Derivative Instrument Charter, including an appendix entitled Derivative Risk Measurement and Management, details the risks and risk management processes used by the Investment Manager. 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 events 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 Manager believes 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 Manager using portfolio risk assessment tools for portfolio construction.

RISK SENSITIVITY ANALYSIS

Interest rate risk sensitivity analysisBased on the financial instruments held and interest rates at the Balance Sheet date, an increase of 0.25% in interest rates throughout the year, with all other variables held constant, would have increased the loss after taxation for the year and decreased the net assets of the Company by £1,106,000 (2021: decreased the profit after taxation and decreased the net assets by £1,312,000). A decrease of 0.25% in interest rates throughout the year would have had an equal but opposite effect.

Foreign currency risk sensitivity analysisBased on the financial assets and liabilities held and currency exchange rates ruling at the Balance Sheet date, a strengthening of the UK sterling exchange rate by 10% against other currencies, with all other variables held constant, would have increased the loss after taxation for the year and decreased the net assets of the Company (2021: decreased the profit after taxation and decreased the net assets) by the following amounts:

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 loss after taxation for the year and increased the net assets of the Company (2021: increased the profit after taxation and increased the net assets) by the following amounts:

Other price risk sensitivity analysisChanges in market prices affect the 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 above.

An increase of 10% in the share prices of the listed investments held at the Balance Sheet date would have decreased the loss after taxation for the year and increased the net assets of the Company by £117,084,000 (2021: increased the profit after taxation and increased the net assets by £200,081,000). A decrease of 10% in share prices of the investments designated at fair value through profit or loss would have had an equal but opposite effect.

An increase of 10% in the valuation of unlisted investments held at the Balance Sheet date would have decreased the loss after taxation for the year and increased the net assets of the Company by £19,465,000 (2021: increased the profit after taxation and increased the net assets by £16,646,000). A decrease of 10% in the valuation would have had an equal but opposite effect.

Derivative instruments exposure sensitivity analysisThe Company invests in derivative instruments to gain or reduce 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 £36,359,000 (2021: increased the profit after taxation and increased the net assets by £41,512,000). A decrease of 10% in share prices of the investments underlying the derivative instruments would have had an equal but opposite effect.

Fair Value of Financial Assets and LiabilitiesFinancial assets and liabilities are stated in the Balance Sheet at values which are not materially different to their fair values. As explained in Notes 2 (l) and (m) above, investments and derivative instruments are shown at fair value. In the case of cash at bank, 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.

Fair Value HierarchyThe Company is required to disclose the fair value hierarchy that classifies its 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.

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 Notes 2 (l) and (m). The table below sets out the Company’s fair value hierarchy:

Level 3 Investments (unlisted and delisted investments)

Pony.aiPony.ai develops artificial intelligence and autonomous driving technology solutions for transportation and is an unlisted company. The valuation at 31 March 2022 is based on a review of a funding round in January 2022 at a US$8.5 billion valuation, the company’s financial performance, the macro-environment and benchmarking the position to a range of comparable market data. As at 31 March 2022, its fair value was £41,134,000 (book cost: £24,892,000).

DJI InternationalDJI International is a manufacturer of drones and is an unlisted company. The valuation at 31 March 2022 is as follows: the D shares valuation is based on the strike price of the put option in place and the B shares valuation is based on the company’s performance, the macro-environment and benchmarking the position to a range of comparable market data. As at 31 March 2022, its fair value was £32,363,000 (book cost: £22,416,000).

Venturous HoldingsVenturous Holdings is an investment company with a focus in smart city technology companies and is an unlisted company. The valuation at 31 March 2022 is based on a review of the company’s portfolio including performance, the wider macro-environment and benchmarking the position to a range of comparable market data. As at 31 March 2022, its fair value was £27,831,000 (book cost: £26,029,000).

Chime BiologicsChime Biologics is a China-based Contract Development and Manufacturing Organization (CDMO) that provides a solution supporting customers from early-stage biopharmaceutical development through late-stage clinical and commercial manufacturing and is an unlisted company. The valuation at 31 March 2022 is based on analysis of the company performance, the terms of the convertible note and benchmarking the position to a range of comparable market data. As at 31 March 2022, its fair value was £27,081,000 (book cost: £25,227,000).

ByteDanceByteDance develops application software and is an unlisted company. The valuation at 31 March 2022 is based on the company’s performance, the macro-environment and benchmarking the position to a range of comparable market data. As at 31 March 2022, its fair value was £25,773,000 (book cost: £7,361,000).

Tuhu CarTuhu Car is an online retailer of automobile spare parts and is an unlisted company. The valuation at 31 March 2022 is based on the cost of the investment when it was purchased in June 2021 with consideration given to the company’s performance, the macro-environment and benchmarking the position to a range of comparable market data. As at 31 March 2022, its fair value was £14,296,000 (book cost: £13,129,000).

Cutia TherapeuticsCutia Therapeutics is a specialty pharmaceutical company and is an unlisted company. The valuation at 31 March 2022 is based on the cost of the investment when it was purchased in September 2021 with consideration given to the company’s performance, the macro-environment and benchmarking the position to a range of comparable market data. As at 31 March 2022, its fair value was £10,720,000 (book cost: £10,266,000).

BeisenBeisen is a Chinese talent management company that offers talent management and measurement solutions and is an unlisted company. The valuation at 31 March 2022 is based on the cost of the investment when it was purchased in April 2021 with consideration given to the company’s performance, the macro-environment and benchmarking the position to a range of comparable market data. As at 31 March 2022, its fair value was £10,656,000 (book cost: £11,758,000).

Xiaoju Kuaizhi (Didi Chuxing)Xiaoju Kuaizhi (Didi Chuxing) is a leading Chinese e-commerce company providing transport services. The Company holds unlisted preference shares awaiting conversion to American Depositary Shares (ADS). The valuation at 31 March 2022 is based on the price of the ADS with a conversion rate applied. As at 31 March 2022, its fair value was £4,796,000 (book cost: £9,971,000).

Since the year ended 31 March 2022, the company’s preference shares have been converted to ADS shares. See Note 22 for further details.

Shanghai YiguoShanghai Yiguo operates an e-commerce platform, selling fruit and vegetables online to customers in China and is an unlisted company. The company has commenced liquidation proceedings and following internal review, the valuation at £nil remained appropriate as at 31 March 2022 (book cost: £11,806,000).

Companies whose listings are suspendedFour listed companies in the portfolio have had their listing suspended: DBA Telecommunication (Asia) Limited (suspended July 2014), China Animal Healthcare Limited (suspended March 2015), BNN Technology Limited (suspended September 2017) and G3 Exploration (suspended October 2020). As at 31 March 2022, each holding has been valued at £nil.

Significant holdingsDetails of significant holdings are noted below in accordance with the disclosure requirements of paragraph 82 of the AIC SORP. The Company is required to provide a list of all investments at the balance sheet date with a value greater than 5% if its portfolio and at least the ten largest investments, including the value of each investment, and for unlisted investments included in the list, additional detail is required as shown below. This disclosure includes turnover, pre-tax profits and net assets attributable to investors, as reported within the most recently audited financial statements of the investee companies.

* Financial instruments are transferred out of level 3 when they become listed.

20 Capital Resources and GearingThe 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 on the Balance Sheet. The Company 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 above and in Note 19 above.

The Company’s gearing at the year end is set out below:

1 Exposure to the market expressed as a percentage of Net Assets.

2 Gearing is the amount by which Gross Asset Exposure/net exposure exceeds Net Assets expressed as a percentage of Net Assets.

1 Exposure to the market expressed as a percentage of Net Assets.

2 Gearing is the amount by which Gross Asset Exposure/net exposure exceeds Net Assets expressed as a percentage of Net Assets.

21 Transactions with the Manager and Related PartiesFIL Investment Services (UK) Limited is the Company’s Alternative Investment Fund Manager and has delegated portfolio management to FIL Investment Management (Hong Kong) Limited. Both are Fidelity group companies.

Details of the current fee arrangements are given in the Directors’ Report in the Annual Report. During the year, management fees of £19,643,000 (2021: £18,591,000), and accounting, administration and secretarial fees of £nil (2021: £100,000) were payable to the Manager. At the Balance Sheet date, management fees of £1,307,000 (2021: £2,094,000), and accounting, administration and secretarial fees of £nil (2021: £8,000) were accrued and included in other payables. Fidelity also provides the Company with marketing services. The total amount payable for these services was £264,000 (2021: £195,000). At the Balance Sheet date, marketing services of £4,000 (2021: £17,000) were accrued and included in other payables.

Disclosures of the Directors’ interests in the shares of the Company and fees and taxable expenses, relating to reasonable travel expenses, payable to the Directors are given in the Directors’ Remuneration Report in the Annual Report. In addition to the fees and taxable expenses disclosed in the Directors’ Remuneration Report, £19,000 (2021: £17,000) of employers’ National Insurance contributions were paid by the Company. At the Balance Sheet date, Directors’ fees of £15,000 (2021: £14,000) were accrued and payable.

22 Post Balance Sheet EventSubsequent to the year ended 31 March 2022, the Company elected to convert its holding of unlisted preference shares in Xiaoju Kuaizhi (Didi Chuxing) to listed American Depositary Shares (ADS). There was no impact on the net assets of the Company as a result of this conversion. Subsequently, the company announced its plans to delist from the New York Stock Exchange with the purpose of relisting on another exchange.

Alternative Performance Measures

Discount/PremiumThe discount/premium is considered to be an Alternative Performance Measure. It is the difference between the NAV of the Company and the share price and is expressed as a percentage of the NAV. Details of the Company's discount/premium are on the Financial Highlights page in the Annual Report and are both defined in the Glossary of Terms in the Annual Report.

GearingGearing is considered to be an Alternative Performance Measure. See Note 20 above for details of the Company’s gearing.

Net Asset Value ("NAV") per Ordinary ShareThe NAV per Ordinary Share is considered to be an Alternative Performance Measure. See the Balance Sheet and Note 18 above for further details.

Ongoing chargesOngoing charges are considered to be an Alternative Performance Measure. The ongoing charges ratio has been calculated in accordance with guidance issued by the AIC as the total of management fees and other expenses expressed as a percentage of the average net assets throughout the year.

Revenue, Capital and Total Earnings per ShareRevenue, capital and total earnings per share are considered to be Alternative Performance Measures. See the Income Statement and Note 8 above for further details.

Total Return PerformanceTotal return performance is considered to be an Alternative Performance Measure. NAV per share total return includes reinvestment of the dividend in the NAV of the Company on the ex-dividend date. Share price total return includes the reinvestment of the net dividend in the month that the share price goes ex-dividend.

The tables below provide information relating to the NAV per share and share prices of the Company, the impact of the dividend reinvestments and the total returns for the years ended 31 March 2022 and 31 March 2021.

The Annual Financial Report Announcement is not the Company's statutory accounts. The above results for the year ended 31 March 2022 are an abridged version of the Company's full Annual Report and Financial Statements, which have been approved and audited with an unqualified report. The 2021 and 2022 statutory accounts received unqualified reports from the Company's Auditor and did not include any reference to matters to which the Auditor drew attention by way of emphasis without qualifying the reports and did not contain a statement under s.498 of the Companies Act 2006. The financial information for 2021 is derived from the statutory accounts for 2021 which have been delivered to the Registrar of Companies. The 2021 Financial Statements will be filed with the Registrar of Companies in due course.

A copy of the above results announcement will be available on the Company's website at www.fidelity.co.uk/china within two working days.

A copy of the Annual Report 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 will be posted to shareholders later this month and additional copies will be available from the registered office of the Company and on the Company's website: www.fidelity.co.uk/china where up to date information on the Company, including daily NAV and share prices, factsheets and other information can also be found.

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.

ENDS