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Alex Wright: Why UK investors need ‘absolute value’ more than ever

16 March 2018

The Fidelity Special Situations manager explains why value can still be found in the UK market, even after the post-crisis recovery.

By Gary Jackson,

FE Trustnet

It could be more important than ever for investors to focus on finding genuine value in the UK, given the fact that equity markets look especially vulnerable because of their lofty valuations, the prospect of higher inflation and the likelihood of rising interest rates.

This is the view of FE Alpha Manager Alex Wright, who runs the £3.3bn Fidelity Special Situations fund. Wright thinks that after nine years of bull market conditions, value investors need to be doing more than buying companies simply because they are cheaper than their peers.

“We can always point to stocks which appear relatively cheap. But for real value investors, there is something unsatisfactory about making claims for ‘cheapness’ based on a comparison to another asset which may itself be expensive and over-valued,” he said.

“Nearly nine years into a bull market, there are certainly plenty of stocks which fit this description. With the market’s overall valuation looking vulnerable in the face of higher inflation and interest rates, I think now is a good time to look at which stocks offer absolute value, as well as being relatively cheap.”

Performance of index over 9yrs

 

Source: FE Analytics

Wright pointed out that the perception of value is always subjective, but added that some methods are more subjective than others.

Ascertaining the value of a company on its future earnings only works as long as these earnings are forecasted accurately, the manager noted, and this is not always possible.

However, a stock’s book value is an independent assessment of what a company would be worth in the event of its liquidation. Although this is not a perfect measure, it is seen as a more stable measure of value and relies less on future assumptions; Benjamin Graham, known as ‘the father of value investing’, said book value is one of the best ways of determining the margin of safety available in an investment.

“For me, if a stock trades close to or below its liquidation value, this is as good a definition of ‘absolute value’ as any other. These are unlikely to be the highest quality businesses in the market,” Wright said.


“Investors will be worried about something, and in many cases, will be right to be worried. But, in some cases the market will have over-reacted. If we can identify potential for significant positive change, then the stock will offer a very attractive balance of risk and reward.”

Fidelity Special Situations has 19 stocks, or 23.4 per cent of its portfolio, with a book value below 1.1x (at the end of January 2018), which Wright said gives him confidence that there is still absolute value to be had in the UK market despite much of it trading at high prices compared to historical averages.

The manager highlighted three stocks as examples of where he is finding absolute value, although he stresses that this is in no ways a recommendation to buy.

 

International Personal Finance

This UK small-cap is a leading international home credit and digital provider of consumer finance that has more than 28,600 agents and employees serving 2.3 million customers across 11 international markets.

Performance of stock vs index over 3yrs

 

Source: FE Analytics

“International Personal Finance trades below book value despite being one of the most profitable businesses I own, selling consumer credit in eastern Europe and emerging markets,” Wright said.

“The shares fell dramatically in 2016 after the Polish Ministry of Justice announced plans to cap rates on consumer lending products and the stock’s valuation reflects a worst-case outcome in Poland, although this by no means inevitable.”

 

RBS

The manager said Royal Bank of Scotland, which bailed out by the government in the global financial crisis and continues to be affected by issues stemming from this period, is the most recent of the UK banks he has bought for Fidelity Special Situations.

“This another stock with a large degree of uncertainty related to a political/regulatory event,” he explained.

“The US Department of Justice will at some point announce a fine related to the historical sale of mortgage backed securities, and although the fine will undoubtedly make for a dramatic headline, the bank has enough capital for almost any outcome. In fact, our expectation is that once the fine has been decided, the bank will be able to begin buying back shares below book value. “


John Laing Group

The final stock that the manager highlighted as showing absolute value is John Laing Group, which is an investor and manager of global infrastructure assets.

This part of the market has been hit hard recently by issues such as the Labour Party suggesting it would bring private finance initiative contracts in-house if it wins power and the collapse of facilities management and construction services giant Carillion.

“The market appears to be valuing this company as it values infrastructure funds, hence the discount to NAV,” Wright said. “However, we believe this is the wrong valuation approach, as it ignores the company’s proven ability to ‘compound’ growth through its origination and management activities, which funds are unable to do.”

Performance of fund vs sector and index under Wright

 

Source: FE Analytics

Wright has managed the Fidelity Special Situations fund since January 2014. Since then, the four FE Crown-rated fund has posted a 42.84 per cent total return, outperforming its FTSE All Share benchmark by a wide margin and putting it in the top quartile of the IA UK All Companies sector.

The fund, which is managed with a contrarian approach and often focuses on small- and mid-cap stocks, is a respected offering among investment analysts. Square Mile, which gives the fund an ‘A’ rating, said: “The contrarian approach and bias further down the market capitalisation scale will unashamedly be important drivers of return, a fact that has been borne out in relative performance; although this can lead to higher levels of volatility compared to the wider market at times.”

Fidelity Special Situations has an ongoing charges figure (OCF) of 0.94 per cent.

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