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FUND TIP: Fidelity European Values. BUY
August 11, 2011

Bull points:

■ Potential for discount to tighten

■ European shares cheap

■ Performance improving

■ Small exposure to southern Europe

Bear points:

■ Potential for TER to rise

■ Manager more experienced in UK equities

IC TIP: Buy at 1043p

IC TIP RATING

Type style: VALUE

Risk Rating: HIGH

Timescale: LONG-TERM

Debt problems in Europe and resulting market slides mean concerns for finance ministers and bond investors, but for some equity investors a brilliant buying opportunity, with European share valuations very oversold. European companies are generally in much better shape than European economies.

If you are looking to exploit cheap assets, you can boost your returns further if you do it via an investment trust at a discount to net asset value (NAV). For Europe, a good option could be the Fidelity European Values investment trust which is trading on a discount to NAV of around 12 per cent. That discount could narrow because of improving performance due to the appointment of a new fund manager in January this year.

The investment trust has performed poorly over three and five years, failing to beat its benchmark. But both its NAV and share price returns have beaten the benchmark, FTSE World Europe ex UK, over six months and one year. Although the discount is already tighter, at around 12 per cent rather than 17 per cent as recently as in March, Tom Tuite Dalton, analyst at broker Oriel Securities, believes it could tighten further.

As well as improving performance and the potential for European stocks to rise in future, the investment trust has an active discount management policy. For example, it bought back 1.5m shares over the six months to 30 June adding 6.2p or 0.5 per cent to NAV.

Since taking over the trust in January Sam Morse has reduced the portfolio to less than 60 holdings, cutting areas which do not fit his investment criteria such as low growth mature cyclicals. The aim is for the portfolio to be fairly concentrated at between 50 to 60 stocks, and have low turnover with a typical holding period of three to five years.

When selecting stocks Mr Morse has four key criteria:

• Positive fundamentals such as structural growth and a proven business model:

• Cash generation

• Strong balance sheet; and

• Attractive valuation.

Fidelity says attractively valued stocks in the portfolio should be able to sustain dividend growth in different economic scenarios and make progress despite a choppy economic and political back-drop.

In any case, the investment trust has little exposure to the troubled parts of Europe, with Italy and Spain accounting for just over 8 per cent of assets, and virtually no exposure to the other troubled economies. That said, Mr Morse chooses stocks according to companies' attributes rather than sector or country considerations.

Fidelity European Values portfolio is very similar to the open-ended fund Mr Morse runs, Fidelity European Fund, but the investment trust has a much cheaper total expense ratio of 0.92 per cent in contrast to the open-ended fund's 1.72 per cent total-expense ratio (TER). However, the investment trust levies a performance fee of 20 per cent of any change in NAV above the returns on the FTSE World Europe (ex UK) index plus 0.5 per cent. This means Fidelity European Value’s TER could rise though probably not to the level of the open-ended fund.

Fidelity European Values is also the largest European investment trust with a market cap of around £512m, so the shares should be easy to buy and sell.

Mr Morse has only been running European equities since the start of 2010. But he is an experienced fund manager having run UK equities at Fidelity between 2003 and 2010, before which he was head of UK equities at M&G between 1997 and 2003. BUY.

Key fund data:

FIDELITY EUROPEAN VALUES (FEV)

PRICE1,043pNAV1,235p
MARKET CAP£512.6mPRICE DISCOUNT TO NAV12.02%
No OF HOLDINGS:50-60*6-MTH  NAV PERFORMANCE0.55%
SET UP DATE5 November 1991*1-YEAR NAV PERFORMANCE15.59%
MANAGER START DATE1 January 19113-YEAR NAV PERFORMANCE11.03%
GEARING111%TOTAL EXPENSE RATIO0.92%
YIELD1.62%MORE DETAILSwww.fidelity.co.uk

Source: Investors Chronicle, *Fidelity.

Performance data as at 8 August 2011.

TOP 10 HOLDINGS as at 30 June 2011

Holding Percentage (%)
Nestle5.8
Sanofi-Aventis3.5
BNP Paribas3.2
Novo-Nordisk3.2
SAP3.0
Schneider Electric3.0
Siemens2.6
Saipem2.6
UBS2.4
Societe Generale2.4

Geographical breakdown:

CountryPercentage
France21.2
Germany19.3
Switzerland16.5
Italy6.6
Belgium6.6
Netherlands6.0
Sweden5.5
Denmark5.0
Norway3.5
Brazil2.1
Spain1.7
Finland1.6
United Kingdom1.5
Other2.9