Expert interview – Fidelity Special Situations Portfolio Manager

It’s good to remember with investment your capital is at risk, and you could lose money. Past performance is not a guide to future performance.

1 – For those new to the fund, can you talk about what you're trying to achieve for investors, and how you go about building the portfolio to deliver that?

The market is often slow to recognise change in out-of-favour stocks, and this creates opportunities to add value by identifying companies whose improving growth prospects are not yet recognised by other investors. This typically means investing in companies that have already underperformed and where there is little or no value ascribed to any recovery potential.

The fund employs a contrarian stock picking investment strategy – it focuses on unloved companies entering a period of positive change.

The philosophy is centred around the assumption that if general market sentiment towards a company is poor, we don’t take unnecessary balance sheet risks and if the market’s low expectations prove correct, there is limited downside as this consensus view is already reflected in the share price.

On the other hand, if things unexpectedly improve, there is significant upside as the consensus view changes and new investors buy into the story. We look for ideas across sectors and invest in companies of all sizes.

The fund typically has a small to mid-cap bias, as this part of the market is typically under-researched and therefore richer in attractively valued investment opportunities.

To maintain adequate levels of diversification and exposure to smaller companies, the fund usually holds over 100 positions, allowing us to be patient and have lots of shots on goal. It can take time for a turnaround to bear fruit and investors to buy into the story. A diversified portfolio means that we are not reliant on the recovery of a specific holding.

2 – The UK market has been overshadowed by the US market in recent years, particularly its tech stocks including the Magnificent 7. What do you believe the case is for continuing to invest in the UK?

While UK equities have been through a period of poor relative returns following the Brexit referendum in 2016, they have started to outperform global stock markets more recently, a fact that has gone largely unnoticed by investors.

As a contrarian value investor, I would rather invest in attractively valued companies whose share price reflect low expectations rather than ones – no matter how great businesses they are – priced for perfection and whose shares are likely to fall precipitously should they disappoint, or market assumptions prove unrealistic.

While UK corporate earnings have improved, valuations have remained largely unchanged.  As a result, the UK market trades on 10-11 times price to earnings (PE) multiples, which compares very favourably to the US market, which is trading on PE multiples of 17-18 times.

This valuation differential exists across the market capitalisation spectrum – small, medium and large cap – which we believe makes the UK a very attractive place to invest our fund.

3 – Fidelity is one of the largest asset managers in the world. Can you talk about the team you work with on the fund, but also the people and resources you use from across the wider business at Fidelity and the advantages that brings?

Fidelity has over 170 equity research professionals located in various locations around the world. The strength and depth of Fidelity’s global research platform means that there is always plenty of strong investment ideas to build a diversified portfolio.

While the fund invests primarily in UK companies, a significant portion of their revenues is generated overseas and they typically compete with global peers, so getting insights from our European, US and Asian analysts is really helpful.

The industry expertise of our analysts allows us to monitor industry developments and maintain a sectorally-diversified portfolio. Areas such as banks and insurers are often shunned by market participants due to their complexity, typically resulting in an above-average number of investment opportunities.

Having career analysts covering these areas is a key competitive advantage. Our focus on unloved companies often facing short-term difficulties requires extensive due diligence to assess the likelihood these changes will prove successful.

We also have market research specialists and a data mining team who can also help us monitor demand on the ground as well as online trends.

While we place significant emphasis on meeting and interacting with management teams to fully understand their corporate strategy, our analysts also speak to competitors, customers, suppliers and industry experts to build conviction in the downside protection and positive change thesis.

4 – You're primarily a value investor. Can you talk about the value you see in the UK market at the moment, any particular sectors where you see particularly good opportunities and what catalysts there are to unlock that value?

The UK is a large and diverse market with over a thousand companies to choose from and strong corporate governance standards. We currently are finding overlooked companies with good upside potential across industries and the market cap spectrum. The lack of interest in UK equities means that, despite our focus on attractive valuations, we do not have to compromise on quality.

While the value in the UK market is not being recognised by investors, it is being acknowledged by other market participants, mainly US corporates and private equity firms who have been buying UK quoted assets, often at significant premiums to prevailing share prices.

The low valuations are also reflected in the substantial buyback activity among UK corporates. The relative attractiveness of UK valuations versus other markets, as well as the large divergence in performance between different parts of the market, create good opportunities for attractive returns from UK stocks on a three-to-five-year view.

With its high dividends and low valuations, the UK market offers better prospective returns than many other asset classes, including global equities. 

5 – Can you take us through some of the recent buys and sells in the portfolio, and outline the rationale behind them?

The underperformance of smaller companies has been a key feature of the past couple of years, and this has presented us with interesting investment opportunities. One such stock we bought is a company called Ascential, whose recent share price volatility typifies the current UK market malaise. This is what we are seeing with a lot of UK stocks.

Overseas competitors and private equity firms are seeing the value and are taking advantage of those attractive valuations. We have had quite a lot of success with M&A across the portfolio in the last 12 months.

Ascential

• A little over 12 months ago, Ascential said that they were going to split up their business, which is a conglomerate made up of three different businesses. They were looking to sell one and list the other so they could focus on their core events business.
• The stock initially went up about 20% on that announcement. But a large amount of their shareholder base were funds that were seeing redemptions. So, interestingly, the stock totally retraced its gains, despite the fact nothing had changed.
• To us, that looked really interesting. There was a plan in motion and it made a lot of strategic sense. We looked at the valuation comps in other markets, and they were much higher, meaning there probably were willing buyers of those assets.
• So, we started buying the stock in the summer last year. And it has worked very quickly, after they announced in late October that they had found buyers for their two assets and the stock performed very strongly.

We are not buy-and-hold investors. When a stock has reached what we consider a fair valuation, we look to recycle proceeds into opportunities with better downside protection and more promising upside potential.

Marks & Spencer

• A stock we sold after strong returns was Marks & Spencer, where we felt the investment thesis had played out.
• The stock had doubled having taken market share in the clothing, home and food segments benefiting from the exit of the likes of New Look, Arcadia and Debenhams, favourable weather conditions as well as a switch from online back to shops after the pandemic.
• The company is trying to broaden the appeal of its high-end grocery by selling more staples and at affordable rates to consumers, and market sentiment was becoming overwhelmingly positive
• After such a strong run, we felt the risk/return was more skewed to the downside given a wide range of scenarios in a relatively weak economic environment
• As a result, it made sense to take profits in strong performers like M&S.
  
  

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