A high weighting to small and mid-caps as well as a number of successful stock and sector calls have been the major drivers of Fidelity Special Situation’s outperformance so far this year, according to its highly-rated manager Alex Wright.
FE Alpha Manger Wright is commonly regarded as one of the brightest talents in fund management industry thanks to his stellar track record as manager of the five crown-rated Fidelity UK Smaller Companies fund – which has topped its peer group since launch in February 2008.
Performance of fund versus sector and index since Feb 2008
Source: FE Analytics
However, when he was handed the reins of the group’s flagship Special Situations fund from the departing Sanjeev Shah, questions were asked if he would be able to replicate his strong past performance in his new portfolio.
While the manager follows the same value/contrarian style as the fund’s former managers – Shah and Anthony Bolton before him – concerns were raised whether he would be able to cope running a larger pot of money and whether he could continue to implement his approach with a more large-cap biased portfolio.
Unfortunately, after taking charge of the £2.9bn fund in January 2014, his first year was somewhat of a struggle.
Though not disastrous, the fund was a bottom quartile performer in the IA UK All Companies sector and underperformed against its FTSE All Share benchmark with losses of 1.66 per cent, according to FE Analytics.
Performance of fund versus sector and index in 2014
Source: FE Analytics
However, the manager says he wasn’t overly fazed by last year’s underperformance as there were a number of contributing factors to his fund’s losses. 
“If you are running a contrarian strategy I think it is unlikely to outperform every single year. While I have managed to do that with the Smaller Companies fund, that was not the case with Special Situations when were slightly underperformed last year,” Wright (pictured) said.
“I think a key reason for that is when you look at the performance of small-caps last year, particularly from the end of the first quarter when we saw a strong underperformance. Clearly, given I have that mid and small-cap bias in the fund, it was quite a headwind to performance.”
As a result of profit taking from 2013’s stellar gains, a period of falling appetite for risk among investors thanks to growing macroeconomic headwinds and outflows from notable small and multi-cap funds, smaller companies considerably underperformed against their larger rivals for much of last year.
FE data shows that between Q2 and the end of Q4, the Numis Smaller Companies ex IT index fell 7 per cent compared to a 0.66 per cent loss from the FTSE 100.
However, that trend has reversed so far this year and Wright has taken full advantage.
“That [under performance of small-caps] has turned around somewhat this year and small-caps are now performing better than the overall market and that, with the continued gains from stock selection, has been a benefit to performance this year.”
According to FE Analytics, Fidelity Special Situations is a top decile performer year to date with returns of 13.18 per cent meaning it has doubled the returns of its benchmark in the process.
Performance of fund versus sector and index in 2015
Source: FE Analytics
While it is only over a relatively short period of time, its performance so far this year means Fidelity Special Situations is now outperforming both the sector and index since Wright has been in charge.
The manager is also increasing his weighting to the lower end of the FTSE All Share in an attempt to outperform his peers from here.
“What is interesting and what has changed is that the FTSE 100 has become a bit more expensive – so from being the cheapest part of the market 12 months ago there is now better relative value in the small-cap space.”
“Traditionally, there is also a lot more choice in the small-cap space. Clearly, the FTSE 100 is only 100 companies but the rest of the investible market is around1,000 companies so the chance of finding those uncovered stories with a potential for change is that much higher in the rest of the market.”
He added: “I continue to see ideas in the mid and small-cap space and, if anything, have been moving more into that part of the market.”
The manager points out, however, that it has not just been his high weighting to mid and small-caps (his fund currently has 32.56 per cent in sub-£1bn market cap stocks) which has driven Fidelity Special Situations’ recent outperformance.
He says that his strategy, which revolves around buying unloved and bombed out companies and holding them until there potential value is recognised by the wider market, has been conducive to the recent backdrop.
“The strategy’s outperformance has come principally from our contrarian positions in undervalued cyclical companies,” Wright said.
“Given the generally improving economic fundamentals, the strength of ‘expensive defensives’ (consumer staples, pharma, etc) in much of last year created an opportunity to buy into companies where prospects were significantly improving but valuations remained low.”
“Some of these positions have delivered strong returns for the strategy, and have continued to perform well following the election result last week.”
Some of Wright’s best performing stocks so far this year include Synthomer, the FTSE 250-listed chemicals business, and Regus, which also sits in the mid-cap index and provides global workplace, as they have gained 40 per cent and 20 per cent, respectively.
Performance of stocks versus index in 2015
Source: FE Analytics
More recently, DCC, Homeserve and Lloyds have all made significant contributions to the fund’s performance.
While Wright has only managed Fidelity Special Situations for a relatively short space of time, he already has some notable backers. One of whom is Square Mile, the investment research and consultancy firm, who have handed the fund a ‘positive prospect’ rating.
“This fund is an interesting proposition run by a new, highly motivated and passionate investor, who has already generated some acclaim through his running of a smaller fund,” Square Mile said. “The Special Situations fund is a flagship fund for Fidelity and Wright’s appointment to such a high profile strategy so early in his career reflects Fidelity’s views on his capabilities.”
“It is important to note that given the manager’s contrarian nature, willingness to invest further down the market cap scale and use of derivatives the fund’s performance may, at times, differ greatly from the market.”
Nevertheless, many experts say they need to see Wright build up a longer track record on the fund before they consider investment – especially given the highly competitive nature of the UK multi-cap space with the likes of CF Miton UK Value Opportunities, Schroder Recovery and GLG Undervalued Assets all proving to be very popular.
However Premier’s Simon Evan-Cook, who is a big fan of Wright’s and has been a long-term holder of his Smaller Companies fund, says investors who buy Fidelity Special Sits now will be rewarded in the future.
“I believe Alex can outperform with his larger Special Sits portfolio,” Evan Cook said.
“However, because it’s larger, it therefore has a reduced pool of investments from which he can choose from. As such, I think it’s reasonable to expect the degree of benchmark outperformance and the consistency of that outperformance to be reduced compared to that seen with his small-cap fund.”
Wright’s largest sector weightings is to financials with the likes of HSBC, Lloyds, Barclays, Citgroup and Bank of Ireland all featuring in his portfolio. It must be noted that the fund can take short positions and has 20 per cent invested outside of the UK equity market.
Fidelity Special Situations has a clean ongoing charges figure of 0.94 per cent.
