Capturing cheap UK valuations: Fidelity Special Values

Manager Alex Wright takes a contrarian, bottom-up approach when building a portfolio for Fidelity Special Values (FSV). He looks for companies that are currently out of favour and which have been overlooked by other investors, but Alex, along with co-manager Jonathan Winton and aided by the support of the Fidelity analyst team, believes he can identify those with the potential to change their fortunes and perform a turnaround. The flexibility of the mandate means the trust tends to have a small and mid-cap (SMID) bias when compared to its benchmark (see Portfolio).

The focus on stock selection from the bottom up means that this should be the primary driver of performance over the long term. However, the manager’s contrarian approach means that the trust typically has a value bias, which has had an impact on relative Performance, as has the bias towards SMIDs. FSV has however been one of the top performers compared to its peer group over many time periods though, boosted by strong near-term returns.

Despite this good recent performance, Alex is relatively cautious about the near-term given the macroeconomic uncertainties, and questions the resilience of earnings in certain industries should there be a recession. This is reflected in the trust’s below-average Gearing. Nonetheless, he believes that UK-based companies are particularly cheap as a result of negative sentiment, something that has also been reflected in the trust’s wide Discount versus its own history.

We believe FSV’s contrarian approach is one of its standout features (see Portfolio), as it provides investors with a portfolio with very different exposure to what is available within a tracker, or elsewhere in the AIC UK All Companies sector. Not only this, but the manager’s flexibility allows him to identify opportunities within smaller companies that passive investors would miss out on. This approach has helped the trust become one of the top performers in the sector across a number of time periods. The market rotation to value over the past 18 months has been a recent tailwind, but we believe that the manager’s stock selection prowess over multiple periods is another key asset of the trust (see Performance).

Despite this, the trust is currently trading at a Discount that is towards the wider end of the range in the manager’s tenure, and over one standard deviation wider that the trust’s five-year history. We believe this reflects wider concern over UK companies, rather than the performance and potential of the trust, and could be seen as an opportunity for long-term investors. We understand that the small and mid-cap bias of the trust has been a headwind in the past year, but that current valuations are more than reflecting the negative headlines. Alex has positioned the trust to companies which can show resilience in earnings despite the weakness, and our proprietary KTI Spider Chart (see Performance) has demonstrated that FSV has historically had strong downside protection. As a result, we believe not only that FSV could offer some protection to investors in a challenging market, but also that the trust is well-placed to capture the low valuations on offer in the event of a UK recovery.