Value opportunities and an improving outlook for the financials sector, and banks in particular, has seen FE Alpha Manager Alex Wright increase exposure to more than a third of the flagship Fidelity Special Situations fund.
Wright (pictured), who manages the £3.2bn four FE Crown-rated UK equity fund, said while there had been no significant changes over the past six months, the financials weighting had increased to around 37 per cent of the portfolio.
“The financial weight has crept up, it was always high and has always been high, I think that is a key area where you can add value,” he said.
Wright said the financials weighting has increased from 31 per cent, with banks continuing to represent the largest sub-sector.
Source: FE Analytics
While the banking sub-sector has responded strongly to issues that surfaced following the global financial crisis, however, the FTSE All Share Banks index has struggled to match the returns of the wider sector, as the above chart shows.
However, the manager has continued to build exposure to the banking sector where he has found value. He has added to his Royal Bank of Scotland position in the past few months as the bank continues to recover following the fall-out from the global financial crisis and trades below book value.
“Clearly going into the financial crisis, banks were the riskiest area of the market, partly due to the very high levels of loan growth in the economy and the very high levels of leverage that banks were running to support that loan growth,” he explained.
“Post-crisis, the world is really different and banks are a very different proposition and a much lower risk proposition than they have been historically.”
He said the banks were now more heavily regulated and had also tightened up lending practices, focusing on quality over quantity.
As well as Royal Bank of Scotland, the manager also owns US bank Citi, which represents a 5.7 per cent holding for the fund, Lloyds Bank, Bank of Ireland, AIB and Paragon Bank. Yet, he does not own any of the challenger banks or banking giants HSBC and Barclays where value is less evident or they don't meet Wright's investment criteria.
“Generally what I want to see is banks that have a strong franchise today or that have the potential to generate high returns from a strong franchise going forward,” he said.
The manager said he had also kept out of the “bond proxy” areas such as tobacco, beverages and pharmaceuticals. He added he was steering clear of the metals & mining sector and had a low weight to oil & gas where he has found it difficult to add value.
The most recent additions to the portfolio include Sherborne Investors, PayPoint and Leonardo, while he has sold out of NEX Group, Scandinavian Tobacco Group and Spirent Communications altogether.
Activist investor Sherborne is one of the biggest new positions in the fund, representing a 1.75 per cent weighting in the portfolio.
Wright said it had previously had success investing in the Sherborne ‘B’ vehicle, which was fully invested in private equity investment trust Electra. He said Sherborne represented the type of turnaround process it looked for in companies “but in a more activist way”.
“[Chief executive] Ed Bramson runs the vehicles, looks for companies that are under-earning compared to their future potential, and actually goes in to get some degree of management control to try and enact that change,” Wright explained. “That’s very much in keeping with how we look at companies.
“We look for companies that are under-earning compared to their potential and look to back managements that are doing that. Ed takes that one step further by being more activist and going on to the board of these companies.”
UK mid cap company PayPoint is another new position representing a 0.75 per cent weight in the portfolio. Wright said it was a “utility-like business but with a much stronger balance sheet”, taking payments for gas and electricity at newsagents.
He said the company held net cash and was unlike other utilities companies that were often leveraged.
“The stock has been weak previously after caps imposed on energy prices [were proposed during the general election], which people fear will cap their earnings going forward.”
However, Wright said this had already been priced in as the company primarily dealt with customers on pre-payment meters. He said the company had interesting new products and growth areas, expanding strongly in Romania, for example, and working with local authorities on payments for services.
“Far from a contracting business that the market prices this as, there is the scope for growth and because of that net cash balance sheet [there is] also a very high dividend yield in the 8-9 per cent area,” he explained.
Finally, Leonardo, an Italian-listed company – part of its 20 per cent overseas allocation –operates in the aerospace & defence sector, an area Wright likes “as a whole”.
The manager said there was potential for margins to rise when compared to peers in the sector and had previously been run poorly by management.
New management and rising defence budget spends across Europe to meet the NATO commitments of 2 per cent of GDP have made the company look more attractive, he said.
On the disposals side, NEX Group had proved a very successful investment said the manager, merging with Tullet Prebon and releasing a lot of value in the stock.
With Scandinavian Tobacco Group, the manager took a 7 per cent loss on the back of trading issues, thanks partly to a decline in the European cigar market.
“Scandinavian Tobacco Group was a much less successful investment, where we actually lost money, but I think again showing the benefits of making sure you buy into stocks at low valuations,” he added.
Lastly, Spirent Communications had not turned out as Wright had expected where top-line growth had been a lot tougher, although the fund had made money on that position.
Wright took over management of the fund from Sanjeev Shah in 2014 and he also manages the four crown rated Fidelity Special Values investment trust.
Over three years, the fund has returned 48.97 per cent, compared with a rise of 35.55 per cent for the average IA UK All Companies sector fund and a 34.14 per cent rise for the FTSE All Share benchmark, as the below chart shows.
Performance of fund vs sector & benchmark over 3yrs
Source: FE Trustnet
The fund is also highly-rated by fund research consultancy Square Mile Research, which highlighted Wright's conviction in the investment approach and the resources available to the manager at Fidelity International.
“This fund is managed with a contrarian mindset and invests in all sizes of company, although tends to maintain a bias to medium and smaller sized firms,” analysts at Square Mile Research noted.
“This fund is an interesting proposition run by a reasonably inexperienced but highly motivated and passionate investor.
“It is also a flagship fund for Fidelity and Mr Wright's appointment to such a high-profile strategy at quite an early point in his career reflects Fidelity's view of his capabilities.”
The fund an ongoing charge figure (OCF) of 0.94 per cent.