Fidelity Funds - China Focus Fund

China - On its way torecovery

Q: What is behind the equity market rally and is it sustainable?

Martha Wang: Strong credit and liquidity in the market and signs that the economy is recoveringmore than expected has help boost investor sentiment and has seen Chinese equities perform stronglyyear-to-date.

Evidence points to a rebuilding of global inventory after months of unprecedented destocking andrecord fiscal and monetary easing. While there are risks that the rally may not be sustainable, strongerproduction should boost job levels and we should see further positive effects from the stimulusmeasures that have been implemented. I have already been encouraged by the improvement in creditmarkets and bank lending attitudes. Recent trade data also showed the contraction in exports wasless severe than consensus estimates and investor optimism was further stoked by the PurchasingManagers Index (PMI) data, which has risen above the expansionary threshold of 50 over the last fewmonths. While these could be sustainable market drivers, perhaps a stronger factor is the infrastructurestimulus and the internal demand that it generates.

In contrast, industrial production growth has remained weak, reflecting falling production of consumergoods for export and oversupply in industrial materials such as steel. However, I expect to seecontinued robust domestic consumption, notably in home and auto sales.

The latest economic data suggests that China has managed to achieve its growthtarget but questions remain over the magnitude and sustainability of the recovery.What is clear is that aggressive fiscal and monetary stimulus measures have beeneffective in supporting economic activity. Martha Wang assesses the extent of therecovery in China and strong market upturn so far this year.

Martha Wang is the portfoliomanager of Fidelity Funds -China Focus Fund.

Martha joined Fidelity in mid-2005 and took over managementof Fidelity Funds - China FocusFund in May 2006. Martha hasnearly 16 years experienceresearching Chinese companies,having worked with Indosuez WICarr Securities, First StateInvestments and HSBC AssetManagement.

July 2009

Source: CEIC, JP Morgan, June 2009

China manufacturing PMI Industrial production growth

ANNUALISED PERFORMANCEas at 30 June 2009

Source: Fidelity

Performance figures are in USD terms NAV to NAV with dividendsreinvested. Past performance is not indicative of futureperformance. Since inception date: 18 August 2003

Benchmark: MSCI China Index (Capped 10%)

Q: Is the government’s target of an 8% economic growth rate achievable?

Martha Wang: The stimulus measures implemented by the government are in line with China’s goalto transform itself from an export-based economy to one that relies more heavily on domestic demand.Consequently, the Chinese government has proposed to “revitalise” ten major domestic industriesand has introduced measures to stimulate its property markets.

This recovery has been supported by a healthy banking system that has provided ample liquidity toboost the economy while, at the same time, the government has been able to successfully implementits expansionary monetary and fiscal policies. China also benefits in that it does not have an over-leveraged population, unlike the US and Europe. As a result, so far this year, we have seen manyleading indicators pick up and China’s second quarter GDP rose to 7.9%, putting it on track to achieveits 8% target growth rate.

However, while the level of growth has increased, it is important that the quality of growth is maintained.This is something the Chinese government is focused upon and an area that I continue to monitor.

Q: Do you share the view that China will lead a global economic recovery and, consequently,that Chinese Equities will out-perform?

Martha Wang: Stock markets in China are likely to remain volatile in the near term as the globaleconomic and investment outlook is still uncertain. Global recession presents a challenging operatingenvironment for companies this year.

However, Chinese names could out-perform world equities over the longer term, given China’sstructural growth potential, favourable demographics and high saving rate. This should result insuperior corporate performance and healthy growth in domestic consumption. I am especially positivein view of the country’s strong financial position and the room it has to apply monetary policy stimulus.I believe that firms with strong balance sheets, good execution strategies and solid managementteams should be able to grow their market share and emerge stronger.

Q: The Chinese government has encouraged banks to lend to stimulate the economy. Couldthis result in problems like rising debt defaults?

Martha Wang: We know that Chinese banks have been relatively insulated from the credit crisis dueto a limited involvement in global capital markets. Investors can have confidence in the Chinesefinancial system as there have been no cases of bank insolvency. Credit expansion has helped stabilisethe economy. New loans have soared in March, which is indicative of the expansionary monetarypolicy. While the government has expressed concern over the quality of lending, it is likely to continueto maintain a loose monetary policy. Looking forward, loan growth in likely to moderate in comingmonths.

July 2009

SECTOR ALLOCATION (%)as at 30 June 2009

Fund BenchmarkFinancials 44.6 40.4Energy 10.2 17.9Industrials 9.9 9.0Consumer Discretionary 8.1 3.9Telecoms Sevices 8.0 13.4Information Technology 4.8 4.2Consumer Staples 3.5 3.5Materials 3.4 5.4Utilities 3.2 2.0Cash and Others 4.1 0.2

Source: Fidelity

Benchmark: MSCI China Index (Capped 10%)

Source: CEIC Data Company Limited, CLSA, May 2009

China new Renminbi Bank lending and loan growth

TOP TEN HOLDINGS (%)as at 30 June 2009

Fund BenchmarkChina Construction Bank 9.3 7.7Industrial & CommericalOf China 7.1 6.4China Mobile 5.3 9.9China Petroleum &Chemcial 4.9 2.7Bank Of China 4.7 6.0Pin An Insurance 4.1 1.9Li Ning 3.7 0.5Tencent Holdigs 3.5 2.3China Life Insurance 3.4 6.0China Resources PowerHoldings 3.0 0.8

Source: Fidelity

Benchmark: MSCI China Index (Capped 10%)

July 2009

Q: Has the government been successful in mitigating external weakness by supporting domesticdemand?

Martha Wang: Yes, government policies have been successful in stimulating consumption. Forexample, both central and local government have increased subsidies for low-income households,provided consumption coupons and raised incomes for teachers, civil servants and pensioners. Inaddition, the government has also helped boost end demand. For example, the recovery in passengercar sales was supported by a cut in purchase taxes on cars with small engine sizes. There are alsosigns of a decoupling of growth within China. Previously it was the coastal first tier cities thatexperienced the highest growth levels. However, over Q1, Shanghai GDP only grew by 3.1% year-on-year, compared to some in-land provinces that saw double-digit growth.

Q: Are current valuations still attractive?

Martha Wang: Overall, valuations are slightly above long-term historical averages. However, weshould note there is a wide divergence at the sector level. For example, defensive sectors such astelecoms and utilities have only managed single digit returns, whereas cyclical sectors such asproperty and materials have risen over 50% this year. As a result, valuations in these sectors haverisen to levels that I am not comfortable with and I have therefore reduced exposure, notably inproperty and energy.

Given the surge in the market, I am quite cautious towards valuations and remain disciplined in myinvestment approach. However, there are some sectors where I see more attractive value such aswithin the consumer discretionary space. Certain plays here are supported by robust domestic demandand are likely to benefit from further policies to support demand.

Source: CEIC, JP Morgan, May 2009

Real retail sales growth Passenger car sales

References to specific securities are for illustrative purposesonly and subject to change without notice. They should notbe construed as a recommendation or an advice to transactin the securities.

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Q: How has the fund recently performed?

Martha Wang: Over the second quarter, the fund underperformed its benchmark. Security selectionin the energy sector undermined returns. A below-benchmark exposure to China Shenhua Energyhurt relative returns as share prices rose following robust first-quarter earnings.

I continue to be disciplined in my approach and retain an underweight stance in a number of cyclicalstocks, given their high valuations. Within the real estate sector, not holding Agile Property Holdingsand an underweight in Shimao Property Holdings proved unfavourable. These companies benefitedfrom increasing margins as demand recovered. A position in Jiangsu Expressway detracted due toincreased competition from a high-speed rail line.

Conversely, an overweight allocation in consumer durables and apparel firms added value. A positionin sports clothing manufacturer Li Ning proved profitable, given its improving product developmentand strong balance sheet. Shares in Dongfeng Motor Group rose on the back of an improving automobilemarket outlook.

Q: What changes have you recently made to the fund? Martha Wang: I have raised exposure to financials, especially through adding some banks to myportfolio. I feel these will benefit from accelerating cash flows, supportive government policies andimproving market outlook. I established a new position in Bank of Communications and added to theexisting holding in China Construction Bank. I have also increased holdings in consumer staples asthese should benefit from China’s consumption growth. I bought shares in personal products companiesincluding Hengan International Group and Bawang International.

Conversely, I have reduced exposure to the telecommunications sector as I can now find betteropportunities elsewhere. Exposure to the industrials sector was also trimmed. I disposed off theholding in China Communications Constructions due to its high valuation and the weak outlook forthe ports machinery business.