Fidelity Special Situations – in search of hidden gems

Dominic Rowles | Mon 08 January 2018

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• Alex Wright seeks companies dismissed by other investors, with the potential for a turnaround
• The fund has outperformed the broader UK market over the manager’s tenure despite his investment style being out of favour
• It retains its place on the Wealth 150 list of our favourite funds in the major sectors

Our View

Alex Wright, manager of the Fidelity Special Situations Fund, adopts a contrarian investment approach. He seeks diamonds in the rough: companies that have had a tough time and been overlooked and undervalued by other investors, but with the potential to recover.

The manager has a long history of outperforming the UK stock market by selecting companies he believes have the best prospects. He has been particularly successful investing in higher-risk smaller and medium-sized businesses, according to our analysis, and this fund gives him the opportunity to invest in companies of any size. He also makes use of his flexibility to invest a portion of the fund overseas.

Alex Wright has managed this fund for four years and the results have been encouraging so far. We believe the manager will continue to add value for investors over the longer term, although there are no guarantees. The fund retains its place on the Wealth 150 list of our favourite funds in the major sectors.

The three stage investment cycle

The manager looks for companies that have been dismissed by other investors, possibly because they have been through a difficult period. He invests in those he believes are making changes for the better, which could eventually lead to a rising share price. This can be divided into three parts:

Stage one: company is overlooked

The manager starts by identifying companies that have had a tough time, but where he sees positive change on the horizon that other investors may have missed.

He has found a number of opportunities in the financial sector, which has been out of favour with many investors since the 2008 financial crisis. Financial services firm International Personal Finance, for example, has performed poorly in recent years as investors fear increasing regulation in Poland, the company’s largest market, could affect its lending business. However, there are doubts the new regulation will materialise and, even if it does, Alex Wright believes the company could close this lending business and recoup outstanding loans with no loss to investors.

Stage two: change begins

Companies at stage two of the investment cycle start to be recognised as attractive opportunities by other investors, and the company’s share price will often rise to reflect this.

Alex Wright believes US banking giant Citigroup is at stage two of the cycle. Donald Trump’s promises to lower corporate taxes and reduce banking regulation have benefited the company’s share price over the past year. The company has also passed a number of the US Federal Reserve’s stress tests and gained approval to increase dividends over the next year.

Stage three: recovery

When a company’s earnings and share price have recovered to the level Alex Wright expects, he will gradually sell the investment and reinvest the proceeds into companies entering stage one of the cycle.

An investment in Burford Capital, a company that finances corporate legal cases in exchange for a share of the settlement, has grown significantly since the manager purchased it. He has since sold most of the investment and reinvested the proceeds elsewhere.

Of course, not every company will recover and some could fall further or fail altogether. Alex Wright’s successful long-term track record gives us faith he can identify more winners than losers, although there are no guarantees.

How has the fund performed?

Alex Wright’s approach of seeking undervalued companies has largely been out of favour with investors since he became lead manager of the fund in January 2014. Investors have favoured larger companies that already have more dependable earning streams, which they perceive to be more secure, rather than those that could see a recovery in their earnings following a setback. Despite this, the fund has outperformed the broader UK stock market by 12.0%* over the period, although past performance is not a guide to future returns.

We attribute this performance to the fund’s bias towards small and medium-sized companies, which outperformed larger firms. One of the most recent success stories was bookmakers Ladbrokes Coral, which features amongst the fund’s 10 largest investments. The company’s share price rallied after it was subject to a takeover offer from competitor GVC Holdings.

Past performance is not a guide to the future. Source: Lipper IM *to 31/12/2017

Please note the manager has the ability to ‘short’ companies, which allows the fund to benefit from falling share prices. This can magnify returns when the manager’s views prove correct, but also increases risk. If he gets it wrong, the fund will fall in value.

Find out more about this fund including how to invest

Please read the key features/ key investor information document in addition to the information above.