The unlisted space is now one of the most attractive investment areas in China, according to Dale Nicholls (pictured), manager of the Fidelity China Special Situations trust, who says many of the best companies are now being floated at a much later stage in their development. 
Nicholls has recently introduced three new unlisted holdings into the portfolio; Sensetime, China’s leading AI (artificial intelligence) company, focused on computer vision and deep learning; Bytedance, a content platform operator, whose core product Toutiao is China’s leading news aggregator; and Douyin, known globally for running the TikTok short video platform.
And he hailed the flexibility of investment trusts for allowing him to access these opportunities.
“One thing that I really like as someone who has managed open-ended money for a lot of time is the closed-ended structure,” he explained.
“I think that brings a lot of flexibility and obviously I can adjust the gearing depending on the opportunity. There are less liquidity concerns, which when you’re invested in not only unlisted companies, but also smaller cap companies, can be a challenge.
“So you have the ability to focus less on liquidity.”
Nicholls contrasted this with his experience of running open-ended funds. For example, he said when the market falls, valuations become more attractive, but this is when outflows ramp up and open-ended managers are forced to sell to meet redemptions.
Conversely, when markets are rallying, there tends to be a glut of inflows to invest, just at the time when valuations are at their least attractive.
The manager said this is especially important towards the smaller, more illiquid end of the market – which he favours for generating the highest returns.
“The basic premise is, I think, pretty simple,” he continued. “Because companies are smaller generally, they’re less well covered by the market. There’s less information. And generally, when there’s less information, there’s more mispricing.
“Ideally, I’m investing in mispriced stocks that I think can move to fair value over time.”
There are three factors in particular that Nicholls focuses on when selecting a stock: growth, returns and management.
The manager said growth is more about how big the company can be in 10 or 15 years’ time than whether it can rise 10 per cent or so over the next 12 months. Returns refers to the return on capital – he pointed out a lot of companies that grow quickly don’t have much money left to return to shareholders.
He said management is possibly the most important of the three – particularly when investing in the less researched areas of the market.
“You can have a quality business with great growth potential but management needs to execute it,” he explained.
“Having the right strategy and really executing on that strategy is for us a core part of what we’re doing with the analyst team when we get out there and meet with management.
“We generally start with small positions, and as you build conviction in the management and their execution, the positions tend to get bigger over time.”
He said a strong management is also important for seeing off the threat of competition – which is becoming more of a factor now the Chinese economy is opening up to foreign businesses. However, he said this is not necessarily something to be frightened of.
“I'd much rather see the markets develop and open up,” he continued. “Let's face it, a lot of the foreign companies are already significant players in the market across a whole range of industries, particularly the consumer space: Starbucks and the McDonald's of the world have really successful businesses in China.
“But as a management team recently said to us, competition should be viewed by us as a threat, but also we should learn to excel better from the competition we have.”
Performance of fund vs sector in 5yrs
Source: FE Analytics
Data from FE Analytics shows Fidelity China Special Solutions has made 118.39 per cent over the past five years, compared with 84.81 per cent from its MSCI China index benchmark.
The trust is on a discount of 8.8 per cent compared with 10.23 and 12.32 per cent from its one- and three-year averages.
It has ongoing charge (OCF) of 1.02 per cent and is 26 per cent geared.