Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Alex Wright, manager of the Fidelity Special Situations Fund.
Hi, Alex.
Alex Wright: Hi.
Wall: So, traditionally, the Fidelity Special Situations Fund is a value mid-cap offering. But in recent months and over the last year-and-a-half in fact, you have been moving slightly more into the large-cap space, haven't you?
Wright: So, the fund clearly has a value bias and that's very much still there. And traditionally, you are right, the fund has also had a mid-cap bias and that still is the case. So, we're still overweight mid and small-caps.
But I'd say, definitely in the margins, you are starting to see a bit more value appear in the larger-cap part of the U.K. market and we have been adding some ideas there. So, we bought into Imperial Tobacco, for example, the first time we have owned a tobacco stock and some sort of maybe larger mid-cap names like Bunzl or a DCC have come in as well.
And also, we've been finding more ideas in the more defensive parts of the market. So, for a while, the market really didn't like cyclicals. We are sort of clustered into, I'd say, or the managers into, what I call, expensive defensives back in 2015, 2016. But today, actually, some of those stocks have done quite badly, including some of those ones that I bought into and actually, some of the cyclical ideas have done quite well.
So, the fund is actually quite balanced, both from sort of moving up the market cap spectrum a bit, so reducing some of that historic overweight to mid-caps, although there is an overweight still there and now being much more balanced in terms of equal weight the defensive sectors as a whole.
Wall: And I know you are a stock picker. But some of the reasons why valuations have become compelling are because of macro reasons, because of unpopularity or Brexit uncertainty. How much do you consider those kinds of broad market movements when making this kind of reallocation or is it very much a sort of stock-by-stock basis thing?
Wright: It's very much stock-by-stock. So, what I think we can get an edge on at Fidelity is getting those individual stock-specific stories right. So, if we are finding lots of ideas, particularly if we are finding them in the larger-caps where we can make larger position sizes, we tend to sort of gear up the fund, put more ideas and actually, we are about 3.5% geared today, which is higher than we've been for about 18 months.
So, it's not that I'm necessarily more positive on markets or have a particular view on Brexit. I think that's very difficult to have. It's just on finding a lot of good ideas that look good value today.
Wall: And you said also it's quite balanced in terms of the cyclicality. Perhaps, you could explain a bit more what that sort of breaks down to in terms of sectors?
Wright: Yeah. So, historically, we've had a very high weight in financials and that's still the case. I still like the banks and the insurers. I think there's really good value there. But actually, some industrial stocks, particularly ones that we are facing global growth or Asian markets have done very well and we are quite underweight those.
And then, in terms of defensive sectors, they are quite a large part of the U.K. market. So, staples, utilities, telecoms, sort of classic defensives. Actually, it's still quite difficult, I think, to find value in sort of classical defensive stocks. So, there's a few of them coming in. But actually, there's a lot of, what I would call, hidden defensives in sectors like support services, or even in media where you have noncyclical earning streams where stocks are cheap, but they are not particularly linked to the economic cycle which has been strong in most places of the world with partly the exception of the U.K., which is Brexit related.
Wall: Now, it sounds like the sort of sectors come and go and indeed, even the market cap moves around, but valuation remains core to your process. Do you have a particularly strict selling process? I mean, do you literally set a line in the sand and say, once that stock gets that share price, I'm out?
Wright: No. So, we have target prices on everything and we have both downside and upside target prices. And I think about the range of valuations that the stocks can move to depending on the outcome of the earnings of that company generally going forwards. And we do a lot of work around working out what the earnings of the stock could look like, not just the point estimate, which is hard to get, but a range of potential future outcomes. And sometimes, we underestimate those outcomes.
So, if you have a hard and fast target price, rather than a target multiple, actually, you can sort of miss out when a company's earnings are transformed on the positive side. So, we very much do have those target prices in mind, but they are based on multiples rather than particular point targets. And if things are better than we expected, and I can see why they will continue to be so, we are willing to hold a stock for longer.
Wall: Alex, thank you very much.
Wright: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
