Exploit political uncertainty with Fidelity Special Values

IC TIP RATING

Tip style: GROWTH

Risk rating: HIGH

Timescale: LONG TERM

Mr Wright looks for companies that can significantly improve earnings, while not having this reflected in the share price. He is hoping to take advantage of investments in sectors that other investors are wary of, such as banks. He thinks concerns about possible political interference are obscuring the fundamental qualities and improving economics of these businesses, and that due to extra regulation banks are becoming much simpler and less risky. He holds Lloyds (LLOY), HSBC (HSBA) and Barclays (BARC) as well as Citigroup (US: C) and Bank of Ireland (IRE: BIR).

The trust has a flexible all-cap mandate so it can buy attractive shares across the UK market. Just now Mr Wright thinks small caps are undervalued, and that you can find better opportunities in this area as these are less researched. The trust has increased its weighting to the FTSE SmallCap Index to 18 per cent against 3.4 per cent for its benchmark the FTSE All-Share, while 27 per cent of its assets are in companies with a market capitalisation below £0.5bn.

Fidelity Special Values can invest 20 per cent of its assets overseas so it is not entirely exposed to the UK. For example, Mr Wright recently invested in Sanofi (IND: SANOFI) as he regards its drug pipeline and valuation levels as better than UK-listed AstraZeneca (AZN) and GlaxoSmithKline (GSK).

Election aside, between when Mr Wright took over the running of Fidelity Special Values in September 2012 (a couple of months before our first tip on the trust) and February 2015 it has performed strongly with its net asset value (NAV) up 71 per cent against 37 per cent for the FTSE All-Share, according to broker Winterflood.

The trust's NAV beats the FTSE All-Share and the Association of Investment Companies (AIC) UK All Companies sector average over one, three and five years, but its share price fails to beat the All-Share over one year. It trades at a discount to NAV of 10 per cent, wider than its 12-month average of 7.6 per cent, and one of the widest levels it has been at in around two years - a trend that has affected a number of UK investment trusts.

Over the long term Mr Wright has an outstanding performance record with his open-ended Fidelity UK Smaller Companies Fund (GB00B3SW2T17), so share price performance on Fidelity Special Values could pick up, thereby tightening the discount.

As a result, a number of analysts argue that now could be a good time to get into Fidelity Special Values. Discount tightening should be helped by the trust's new policy, whereby it will seek to maintain the discount in single digits in normal market conditions.

The trust uses derivatives called contracts for difference for short exposure and supplementing long exposure, and futures for short positions and managing currency risk. Mr Wright also looks to invest in companies he thinks have limited downside risk, for example ones on exceptionally cheap valuations or with an asset that should stop their share prices falling below a certain level.

The use of derivatives and bias to small and mid caps makes the trust higher risk as these could increase volatility, while it has underperformed its benchmark over the short term. However, analysts at Winterflood say: "For investors that are comfortable with these risks we believe it is attractive and has significant potential to outperform over the longer term."

So, if you want to exploit the opportunities the current market environment throws up and buy into a manager with a strong record at a discount, now could be a time to consider Fidelity Special Values. Buy.

Source: Morningstar

Performance

Source: Winterflood, as at 5 May 2015

TOP TEN HOLDINGS as at 31 March (%)

Sector breakdown (%)