Investors are wary of China. It is hardly surprising give the impact the volatile market has on global assets. In the summer of 2015 a crash in the Chinese stock market dragged down its counterparts in the US, Europe and the UK. Fast forward to January 2016 and following the Federal Reserve raising interest rates in the US, the Shanghai Composite fell 1,000 points – taking the FTSE 100 and S&P 500 with it.

But despite this volatility, many investors have made great gains over the past three years investing in Chinese equities. Dale Nicholls, manager of the five-star Fidelity China Special Situations (FCSS) investment trust is one of them. Nicholls took over the management of FCSS from Anthony Bolton in April 2014, and has the share price has since gone from £100 to £194.

Before moving to Hong Kong to set up the China trust in 2010 Bolton had secured an unrivalled reputation as a UK-based fund manager. His Fidelity Special Situations fund had turned an investment of £1,000 into £148,200 during his 27-year tenure. But his skills as a UK and European stock picker did not prove entirely transferable, losing 14% from launch to the time he announced plans to leave the trust in June 2013. He regained these losses before handing over the reins to Nicholls, but the venture could hardly be called a success – having invested in two companies that turned out not to exist.

Unlike Bolton, Nicholls had 18 years’ experience investing in Asian equities before taking over the management of FCSS, some of which was spent managing the Silver Rated Fidelity Pacific fund since 2003.

Morningstar analyst Mark Laidlaw says of the Pacific fund: “The more we see Fidelity Pacific, the higher our conviction becomes. This strategy has a number of strengths, not least the portfolio manager.

“Dale Nicholls has been at Fidelity since 1996 and manager on this strategy since September 2003, an impressive feat that makes him one of the longest-standing managers in the Asia-Pacific inc Japan Morningstar Category. We see him as an astute investor, comfortable discussing the major macro drivers or digging into the minutia at the individual company level.”

What Next for China?

But as any savvy investor knows, past performance is no indicator of future returns. So what should investors expect next from China? Chairman of the trust Nicholas Bull says that concerns about new US President Donald Trump are unfounded.

“The trust is tapping into the growth of the middle class. There is a sense of aspiration in China that is not correlated to foreign policy. What this new middle class is buying – education, healthcare, big brands – is not affected by Trump,” he said.

“The Communist Party has a vested interest to provide the Chinese with stability. We see China as a sea of tranquillity in a world of political uncertainty.”

Nicholls calls this growing middle class “new China”, and has shaped his portfolio to benefit from the demographic trends. He says it is less about the luxury stocks – which saw great gains a few years ago – and more about goods and services, cars and appliances. The insurance market for example, IT services, online payment companies and airports.

“Travel has grown double digits in recent years as the middle class become more affluent and restrictions around travel have been relaxed,” he said. “The railway system has had no pricing adjustment for 20 years and second tier airports currently have very limited retail options. But China’s infrastructure assets compete well on a global basis.”

Nicholls admits that within some sectors “transparency is an issue”. Of the banking sector he says: “I find it hard to believe the levels of non-performing loans which the banks claim”. Similarly State Owned Enterprises he says are “very attractively priced, but difficult to call”. Instead he likes insurance companies and wealth managers as a way to profit from growing affluence.

Unlisted Stocks: A Bold Bet

Nicholls is also wading into less chartered territory, investing in unlisted stocks for the first time; changing changed the trust’s mandate to allow him to invest up to 10% in unlisted companies. The potential for downside is far greater with these types of companies; but at least in a closed-end fund structure investors can be less concerned about liquidity. At present, unlisted companies only make up 4% of the trust, which has around 150 holdings – if one of these bets went under it does not have the power to derail performance.

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