UK banks and oil firms represent some of the best long-term stocks in the UK equity market, according to Alex Wright, manager of the Fidelity Special Situations fund.
Wright (pictured) believes that over the longer term the likes of Barclays, Lloyds and HSBC should see significant upside from their current ‘trough’ positions, with a strong potential to generate dividend growth.
UK banks saw huge falls in the run-up to and the aftershock from the 2008 financial crisis. The likes of Barclays and Lloyds were worst hit. They saw significant losses in 2007 and 2008 with the latter having to be bailed out by the taxpayer. The taxpayer remains largest shareholder with around 20 per cent of the bank’s total stock, although this it looks set to change soon with the government keen to sell.
The ‘big four’ UK banks – Lloyds, HSBC, Barclays and Royal Bank of Scotland – all saw massive falls in their share prices. HSBC lost a ‘mere’ 60 per cent, with the other three falling more than 90 per cent and 97 per cent in the case of RBS.
Performance of banks since 2007
Source: FE Analytics
Wright believes that a combination of an imminent increase in investor appetite for their growing dividends whilst appreciating their increases in balance sheet ‘strength’ will drive their share prices higher.
“You haven’t seen very much re-rating of the banks in the past six years but you have seen dramatically improved capital ratios and therefore increasing safety in banks because of the strength of the balance sheets, which is not reflected in the price that you are paying for them.”
“We expects Lloyds, for example, to be paying out 60 per cent of its profits come 2016 and that gives you a more than 6 per cent dividend yield. Increasingly, income investors have not been in this space because they are worried about regulatory changes and weak balance sheets but in fact I think those are yesterday's problems and the banks have really worked through those challenges.”
“Going forward this sector is going to pay out very high income and will start to attract more income investors. I expect that to lead to a re-rating of these stocks over time.”
Wright also likes oil producers. Oil has been a huge area of weakness over the past 12 months, having seen a rapid plunge in price from $100 a barrier to $45.
Spot oil price over 1yr
Source: FE Analytics
Wright says the poor performance for the stocks following the fall in price has brought about the likelihood of further mergers and acquisitions after Shell’s prospective tie-up with BG was recently announced.
“Oil is very interesting. I have been buying recently and have about an 8 per cent weight, which is still a bit underweight versus the UK market but reflects the fact that Shell and BG looks very interesting,” he explained.
“They are on a 7 per cent dividend yield, which looks very supportable. I have also bought into some of the smaller-cap names such as Nostrum, Faroe and Genel. They all have low costs of production and have done very badly over the last months and therefore have the potential to be M&A targets going forward.”
“This is an area where M&A is likely to step up given it is cheaper to buy companies than it is to find the oil from the ground.”
Wright, who is an FE Alpha Manager, is frequently viewed as one of the emerging talents in the UK fund management industry. He has a clear investment strategy which centres on buying unloved and bombed-out companies in sectors that are out of favour amongst many investors and holding them until their potential value is recognised by the wider market.
He looks for these contrarian ideas in areas where he is expecting perception by the wider market to shift thanks to operational and/or secular change. He then imposes a strict sell-discipline once the recovery has taken place.
The manager took over the £3bn Fidelity Special Situations fund at the beginning of 2014 and despite a rocky start throughout most of that year, when the fund was down against its sector and benchmark, it has moved into positive territory since.
According to FE Analytics, Fidelity Special Situations has returned 10.74 per cent against an IA UK All Companies sector average of 8.34 per cent. The FTSE All Share gained 7.24 per cent.
Performance of fund, sector and index since 1 January 2014
Source: FE Analytics
The manager has brought his value/contrarian style of stock selection from the £282m Fidelity UK Smaller Companies fund, which he has managed since 2008, and the Fidelity Special Values trust, which he took over in 2013.
FE data shows he is the best performing FE Alpha Manager over three, five and seven years thanks to his tenure of the five crown-rated Fidelity UK Smaller Companies fund.
During his career, Wright has returned 302.4 per cent to his investors, meaning he has beaten his peer group composite by more than 200 percentage points.
