An unfair stigma attached to investing in financials and overly bearish sentiment towards the oil price means there are plenty of value opportunities in today’s market, according to Fidelity’s Alex Wright.
The manager, who won FE’s coveted FE Alpha Manager of the Year award earlier this month, said he has therefore managed to outperform his FTSE All Share benchmark year-to-date despite this year’s pullback in the growth/value rotation.
So far in 2017, his four crown-rated Fidelity Special Situations fund has returned 10.13 per cent compared to the index’s return of 7.66 per cent.
Performance of fund vs sector and benchmark in 2017
Source: FE Analytics
“Year-to-date it’s been a very unfriendly time again for value, with essentially all of that rally pretty much given up. So, it’s great to see that the fund has continued to perform well year-to-date and indeed beat the index, despite actually being a very difficult time for value stocks,” Wright (pictured) said. 
“A lot of the hopes around the US reflation trade really haven’t come off effectively. Some of the policy agenda that people were hoping Donald Trump would be able to introduce have not come through as yet and bond yields, which were rising dramatically during the second half of last year, have started to fall again.”
Wright attributed the fund’s performance to strong stock-picking abilities and the deep due diligence he adopts, which reaches far beyond simply buying ‘cheap’ stocks.
For example, the manager has been consistently overweight financials over the last decade, despite overall negative sentiment towards the sector since 2008.
“Because of the overhang from the financial crisis, investors are scared to look at these stocks full-stop,” he explained.
“Then also, there is the added overlay that it is a complicated sector, so a lot of businesses that have very interesting models have difficult-to-understand accounts, and are large companies which are complex.
“I think if you don’t carry out the deep fundamental analysis and have lots of feet on the ground to do the work on these companies, it can be daunting to really unpick the accounts here.”
Wright said this is the reason he has been able to generate such strong returns from financials, both within the diversified financials sub-sector and the market area as a whole.
While banks account for a large part of the sector, he points out that only one-third of his financials exposure – which accounts for 32.7 per cent of the portfolio relative to the All Share’s 26 per cent weighting – is held in these stocks.
“Citi is a very big holding at 5.5 per cent of the fund and Lloyds is another large weighting at about 3.5 per cent. Bank of Ireland is also over 2 per cent,” Wright said.
“Insurance is also an interesting but complex sector. I like the non-life side and primarily motor insurance with Esure and Saga, then also the life insurance side with Aviva and Phoenix being the big positions in the portfolio.
“As the name suggests, our diversified financials exposure is across a broad range of positions and, more often than not, complex and unique business models. Burford and NEX are very good examples; Burford really is a unique model in the litigation financing space as it has very few global peers.
“It is a company that I thought had the potential to generate very high returns because of a large core market which is actually very underserved.”
The manager said the group is growing very quickly and the stock has performed extremely strongly. Not only is it the biggest single contributor to the fund’s gains year-to-date, it is up 850 per cent since the team’s original investment.
Performance of stock in 2017
Source: FE Analytics
“I think it shows that, if you really deep-delve into these unfashionable sectors and complicated business models, there are rich rewards to be had,” he added.
Elsewhere, Wright is positive on the oil & gas sector despite concerns regarding the oil price across the broader market.
Approximately 10 per cent of Fidelity Special Situations is held in the sector, with Shell accounting for 6.5 per cent of the overall portfolio.
As part of maintaining this exposure, Wright frequently travels to the Permian Basin – an oil deposit stretching across Texas and New Mexico. His last visit was in March this year, when he met 19 companies over the course of a week.
“When you’re investing in oil, you really need to understand the Permian Basin,” he said. “We’ve been doing that trip every six months for the last three years, so this was the sixth trip. I think it means we’ve got a very good idea of where global oil break-evens are.
“You can see that break-even prices have been coming down a lot over the past couple of years from the mid-60s down to the mid-40s [in dollars] – particularly so in the Permian Basin.
“I think a lot of investors are seeing that and have used it to construct a structurally bearish view on the oil price. Production in the US has been growing, the cost of that production has been falling and, therefore, they believe the oil price is going to be much lower than it has been in the past.”
While Wright said there is some truth in this outlook, he argued that investors really need to understand the nuances of what is happening.
He said that, following his trip in March, it became evident that some of the reduction in break-evens is the result of improved shale and fracking technology.
“Effectively, the massive fall in the rig count we saw as the prices came off reduced the supply chain margins dramatically so the likes of Schlumberger and Halibut [oilfields] have moved from 20-30 per cent profit margins down to a loss-making position,” the manager continued.
“You saw massive deflation in just the cost of pressure pumping, sand, portable power equipment, availability of water and so on.
“Also as part of that, a lot of people just started using more of those inputs per well. They completed longer fracks, drilled for longer because drilling was cheaper, they put more sand in because sand was cheaper, they pumped more water in because both the pressure pumps were cheaper and there was more water available because there were fewer wells.”
While it looked as though the efficiency of each well was improving, Wright said that there were simply more inputs per well. As such, he believes the consensus bear case for oil is incorrect.
Performance of index over 5yrs
Source: FE Analytics
“Additionally, when you look at the equities, they are quite attractive. I think that even at today’s oil price – Shell, at $50 per barrel, has produced three quarters in a row where they have cash-covered their dividend,” Wright pointed out. “That is something they didn’t do at $100 oil because they were spending very extensively on exploration and Opex [operating expenditure] costs were incredibly high.
“Today they’ve cut back on exploration. They’ve been able to do that because they bought in the long-dated assets from BG which are still ramping up in Brazil, plus their own long-dated LNG [liquid natural gas] assets. The budgets for exploration have also come down because of service costs and clearly Opex costs have fallen again.
“I think you have a really nice picture of a well-supported top-line with upside in terms of the sales numbers because of the oil price and continued declining costs, which means the cash generation of Shell looks very good.
“Its dividend yield of more than 6 per cent looks very well-supported and very attractive, especially versus equity or bond market levels of yield. Shell in particular is something I’m very excited about in energy.”
Since Alex Wright took to the helm of the £3.2bn Fidelity Special Situations fund, it has returned 40.28 per cent compared to its sector average and benchmark’s respective returns of 27.77 and 28.43 per cent.
It has a clean ongoing charges figure of 0.94 per cent.