A Possible Brexit Bargain: Fidelity Special Values

The surprise result of the EU referendum created a lot of panic selling and although most of the Brexit bargains have now recovered there are still one or two opportunities to pick up a good long-term core portfolio holding at an attractive entry level.

A prime example is Fidelity Special Values (LON:FSV), a £500m investment trust that aims to achieve long-term capital growth by investing mainly in UK-listed companies. It is managed by Alex Wright, who has done well since he took over in September 2012.

Wright is a value investor who looks for companies whose share prices have underperformed, but which offer some kind of downside protection. He concentrates on businesses that have the potential to recover and has a bias towards smaller stocks, while having the freedom to invest anywhere on the market cap spectrum.

Fidelity Special Values used to be run by the legendary fund manager Anthony Bolton, but when he stepped down in 2008 the role was given to Sanjeev Shah. Shah struggled to make an impression and four years later he was replaced by Wright, who has also taken charge of the £2.5bn open-ended Fidelity Special Situations fund.

Wright has put together a diversified portfolio of 118 holdings with the ten largest accounting for 37.8% of the fund. These include large and mid-cap stocks such as Royal Dutch Shell, Citigroup, Lloyds Bank, Royal Mail, Ladbrokes and Wolseley. Up to 20% can be invested overseas and the current allocation is close to this limit, with the main international weighting being the 11.1% exposure to the US.

At the end of May he had invested 30.1% of the fund in FTSE 100 stocks, 33.9% in the mid-caps of the FTSE 250 and 13.5% in the FTSE Smallcap, with the rest in the smaller stocks and international companies outside of the FTSE. The biggest underweights relative to the index were the likes of HSBC, British American Tobacco, BP, Vodafone, Glaxo and AstraZeneca where he had zero exposure.

FSV has a decent record since Wright took over and is ranked fifth out of thirteen funds in the UK All Companies sector over three years with a gain of 26.9%. It was the referendum that took the gloss off the performance, as fears about the impact on the British economy have frightened investors into reducing their exposure to UK small- and mid-cap stocks.

At close on June 23^rd, the night of the polls, FSV shares were trading at 198.5 pence, but they have since slipped to 187p, a fall of 5.8%. Over the same period the estimated NAV has held up much better and is virtually unchanged at 206.96p. This means that the discount has widened from 4% to 9.6%.

There is a formal discount management policy in place with the Board aiming to keep the discount ‘in single digits in normal market conditions’. If necessary they can repurchase the company’s shares to achieve this, which suggests that the discount shouldn’t widen much beyond where it is now.

The portfolio of the investment trust is very similar to Wright’s Fidelity Special Situations open-ended fund, which is much larger with £2.5bn of assets under management. This has pretty much the same mandate and the same allocation to the different parts of the index, whilst also sharing many of the largest holdings.

Wright took over the management of Fidelity Special Situations in January 2014, fifteen months after he assumed charge of the investment trust. Over the last few weeks the performance of the two funds has diverged due to the negative investor sentiment affecting the discount, with the investment trust underperforming by around 11% during the 31 month period of joint management.

The small- and mid-cap bias makes FSV and its open-ended counterpart a higher risk proposition than a pure large-cap mandate, but it gives the manager more chance to deliver better long-term returns. This is exacerbated by the relatively high net gearing of 22% in the investment trust.

Fidelity Special Values is currently trading on a 9.6% discount to NAV and yielding 1.8% with semi-annual distributions. It could be a decent opportunity to open a long-term position, as long as you expect the UK economy to muddle through without too much damage as today’s GDP figures seem to suggest.