Fidelity China Special Situations (FCSS) is intent on investing the next generation of Chinese companies, according to manager Dale Nicholls.
FCSS raised the upper limit of what it can hold in unlisted companies from five per cent of the portfolio to 10 per cent at its annual general meeting last July and Nicholls says the unlisted space in the country is 'interesting'. 'There's a great deal of entrepreneurial activity in China,' he adds.
Nicholls has been at the helm of the £1 billion trust for just over three years and has returned 85 per cent for investors in that time, as at 13 March, compared to the benchmark MSCI China index's 55 per cent.
The fund's performance has been helped by the growth of holdings such as Alibaba, which the fund held when the company was unlisted. The firm now has a market cap of over £250 billion and is the second biggest holding in FCSS, accounting for 7.6 per cent of the portfolio.
Nicholls says the reasoning behind upping the limit to which he can hold unlisted firms wasn't because 'deals are coming through the door', though he does have his eyes on more. 'It's about having that flexibility to increase [the amount of unlisted holdings] if the opportunity is there,' he says.
Nicky McCabe, head of investment trusts at Fidelity, adds that it also allows Nicholls to run his winners. 'What you don't want to do is if you've invested in something successful and it starts increasing in value, you don't want to have to sell it down just because you've hit your 5 per cent [limit],' she explains.
FCSS currently has three unlisted holdings, accounting for between 3-3.5 per cent of the trust. The biggest of these, Didi Chixing, is described by Nicholls as 'the Uber of China'. In fact, Didi bought Uber China in August 2016, having merged with its other rival, Kuaidi, in February 2015.
With its competitors now out the way, Nicholls says Didi, which delivers more rides in China alone than Uber does globally, is the clear dominant player in the country's ride-sharing space.
As part of Uber's drive to break into as many markets around the world, the firm burned around $2 billion (£1.6 billion) trying to compete with Didi, only to gain a market share of less than 20 per cent.
'Uber was losing significant amounts of money in China - they [and Didi] both were [before the merger]; but I think the path to profitability now for Didi is pretty clear,' Nicholls says.
Another company where Nicholls sees a clear path to profitability is Meituan, an e-commerce company that runs a deal-of-the-day website. The manager says this is another industry where competitive intensity is being removed, with the market consolidating.
Meituan recently merged with competitor Dianping, giving them 'a clear number one position in the market'. Nicholls says he sees potential for further consolidation in that area, as well.
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The third and most recent unlisted purchase made by the fund is online grocer Yiguo, which is, again, a clear leader in its market - this time due to its ability to utilise its affiliation with, and use the traffic of, Alibaba.
Nicholls adds: 'As Alibaba is the clear leader in e-commerce, that is a huge competitive advantage. It's really hard for me to see how they get usurped by anyone, given the lead that they have in that space.'
As with any market, investing in unlisted companies is 'pretty research intensive' and requires an extra level of due diligence, which means Nicholls is supported by a large team of Mandarin-speaking analysts, based in Shanghai, Hong Kong and Singapore.
Other areas Nicholls likes in China are focused on consumption, with the natural development of the middle-class the biggest theme he sees playing out over the next five to 15 years.
'When I say consumption, I'm not necessarily talking about luxury,' he continues. 'I'm just talking about people wanting to have their cars, wanting to have their appliances, etc - that's really the key thing.
'If you look at an area like autos, [China is] by far the biggest market in the world - and yet the penetration rate still lags the West significantly. There's a whole range of categories where that's the case.
'And it's not just goods, it's services as well. So if you look at my top holdings, my biggest bet in the fund is insurance.
'The penetration rates for insurance are a fraction of what they are in the West, but people are going to want those protection type products over time so it's an area that can continue to grow a lot.'
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