Fidelity Special Values: January 2024 trust update

• Alex Wright's contrarian approach and focus on unloved companies differentiates the trust from some peers

• The manager is supported by Jonathan Winton and a large, well-resourced analyst pool at Fidelity

• The trust has delivered strong performance under Wright’s tenure, outperforming the FTSE All Share index by a considerable margin

How it fits in a portfolio

The Fidelity Special Values trust aims to grow an investment over the long term. The manager's focus on unloved companies differentiates it from many other UK-focused investment trusts, and it could bring diversification to the UK section of a broader investment portfolio. It could sit well alongside other UK trusts that focus on companies capable of growing earnings at a more consistent pace.

Manager

Alex Wright has been at Fidelity since 2001. He started his career analysing European companies and has focused on UK companies since 2008. As an analyst, he worked closely with Anthony Bolton and Sanjeev Shah, the trust’s two previous managers. We think it's positive that he learned his trade from such well-regarded investors.

Wright became a fund manager in 2008, initially focusing on UK smaller companies, but later broadened his remit to include companies of all sizes. He's been lead manager of the Fidelity Special Values investment trust since September 2012 and is also responsible for the Fidelity Special Situations fund, which he’s managed since January 2014. The two portfolios have a high degree of overlap, so we think this is a reasonable workload for an investor of Wright's calibre.

He's supported by co-manager Jonathon Winton and Fidelity's extensive analyst team. We think Wright has the resources required to do his job well.

Process

Wright invests in large, medium-sized and higher-risk smaller companies that often go ignored by other investors. Maybe they've missed a profit target, or the management team made some unpopular decisions. Either way, he must believe the company is on the road to recovery. A company can recover in a variety of ways, such as introducing a new product line, expanding into new areas or hiring a new management team.

Corporate strategy plays an important part in a company's recovery, so the manager spends lots of time meeting company managers. He also meets the clients and suppliers of the companies he invests in to better understand how the company does business.

As the company improves, its share price should rise as other investors begin to recognise the change. As the price rises, Wright gradually takes profits and moves on to the next unloved opportunity. It's an investment style known as 'value' investing. Of course, not every company will recover, and some could fail altogether.

A number of companies held in the trust exited the portfolio over the year following the conclusion of successful bids for them. This included power producer Contour Global and consultancy firm RPS Group.

Investors should be aware the trust can borrow money to invest with the intention of increasing returns (known as gearing), but this could magnify losses in a falling market and increases risk. At the end of the trust's last financial year in August 2023, gearing stood at 6.5%, down from 10% a year earlier. This is in the context of the manager’s cautious economic outlook and the threat this could pose to company earnings, despite attractive valuations on offer. The maximum level of gearing permitted is 40%, but in normal market conditions, investors should expect it to be in the range of 0-25%. The manager can also use derivatives, which if used, adds risk.

Culture

Fidelity was founded in 1969 and is a global investment manager. The company remains privately owned, meaning its managers can focus on the long-term interests of investors rather than short-term shareholder demands. That's helped the firm develop an investment-focused culture, where investment ideas are openly discussed and debated, and information is shared amongst the firm's various teams.

The company's scale means investment teams are well-resourced and fund managers are well-incentivised. We think it's positive that all Fidelity fund managers are incentivised based on the longer-term performance of their funds and investment trusts. We think this aligns their interests with those of investors.

ESG Integration

Fidelity has committed to improving its approach to ESG (Environmental, Social and Governance issues) in recent years. The firm developed a structured engagement program which allows them to be more systematic in their engagement on environmental and social issues, become involved in more collaborative engagement initiatives and introduced ESG data into fund managers’ quarterly reviews to raise awareness of ESG issues. The firm also bolstered its dedicated ESG team, which writes regular ESG reports on companies held by Fidelity fund managers. The firm votes where it is possible to do so and quarterly voting reports are posted online, complete with rationales for votes against management and abstentions.

In June 2019, Fidelity launched its own proprietary ESG ratings tool. It scores thousands of companies based on their ESG credentials on a forward-looking basis, with investment analysts tasked with the job of ensuring the ratings are up to date. The ratings system has recently evolved to include an assessment of each company’s ability to manage negative externalities. Fidelity is also rolling out a climate rating which identifies companies they should engage with most as part of their aim to halve portfolio emissions by 2030 and reach net zero by 2050. While Fidelity has made strides forward at the firm level, we don’t think this has fully fed through to the fund level. While there is plenty of ESG information available to all Fidelity fund managers, we’re not yet convinced they all put it to full use.

Cost

The ongoing annual charge over the trust’s financial year to 31 August 2023 was 0.70%. Investors should refer to the latest annual reports and accounts, and Key Information Document for details of the risks and charging structure.

If held in a SIPP or ISA, the HL platform fee of 0.45% per annum (capped at £200 per annum for a SIPP and £45 per annum for an ISA) also applies. The HL platform fee doesn't apply if held in a Fund and Share Account. As investment trusts trade like shares, both a buy and sell instruction will be subject to the HL share dealing charges.

Performance

The trust's performed well over the long term. Its share price has risen 248.12%* since Wright became manager in September 2012, beating the FTSE All Share index's return of 113.20%. We think this is an impressive achievement, particularly as the manager's value-focused investment approach has been out of favour for much of this period. The value investing style has had a better last three years but prior to that, investors generally preferred companies with the potential to grow earnings more consistently, otherwise known as 'growth' stocks. Past performance is not a guide to the future.

Over the trust's last financial year to the end of August 2023, its shares rose in value by 5.6% compared with a return of 5.2% for the FTSE All-Share index. The trust’s net asset value (NAV) grew by 5.9% over the year, with a slight widening of the discount it trades on accounting for the differential between the NAV and share price return.

In the rising interest rate environment we’ve seen in the UK, the trust’s overweight exposure to banks was a significant contributor to performance. Ireland based AIB Group and TBC Bank Group were among the key individual stock contributors here. Other strong performers in the trust were the retailer Marks & Spencer Group which took market share in both clothing and food despite a cost-of-living crisis, and airliner Ryanair which has benefitted from a resurgence in post covid travel demand.

In terms of detractors from performance, North Sea producer Ithaca Energy was the largest, following the introduction of a windfall tax. Drink distributor C&C Group also suffered from the slow recovery in post covid pub demand as well as rising costs and problems with implementing a new IT system.

In the trust's financial year to the end of August 2023, total dividends paid to shareholders amounted to 8.80p per share. This is a 13.5% increase on the dividend per share paid in the previous year.

At the time of writing the trust trades at a discount of 6.39% and has a dividend yield of 3.22%, although remember, yields like dividends are variable and aren't a reliable indicator of future income.