The extent to which valuations in the UK were depressed has still yet to be realised, according to Alex Wright, manager of the £809.8m Fidelity Special Values investment trust, and will continue to outperform now the cloud of Brexit has been lifted.
After the value resurgence that started in November, some have questioned how much momentum is left but Wright argued that due to the UK’s low starting point in terms of valuations, there is still a tremendous amount of value to be found in relation its global peers.
“Yes, there’s been a strong bounce-back, but it’s coming from an incredibly depressed level,” he said. “There’s still a huge level of opportunity here and I think we’re just at the start of a potential long-term period where value comes back.”
The UK was hit hard by the coronavirus pandemic, especially in comparison to other developed economies.
Wright said this was partly down to mismanagement during the pandemic, but mainly due to the economic make-up of the UK market.
The consumption basket in the UK is comprised of the restaurant, hotel and travel industries, all of which were heavily affected by social distancing and nationwide restrictions. This, therefore, hit GDP hard in Q2 of 2020.
“However, because these were restrictions, you had a very unusual recession that led to a huge rise in savings rates globally,” said Wright.
Household savings rate soared during the pandemic
Source: FT/OECD, December 2020
As the chart shows, the UK has seen the highest increase out of the developed nations in terms of savings ratio as a percentage of disposable income – rising 13 per cent since 2019.
“The degree of increase-in-savings and the absolute size compared to the economy is really big,” he said. “So the potential for bounce-back in consumer spending post-Covid is particularly high in the UK.”
The UK housing market, a useful barometer of consumer spending and sentiment, has climbed back up to pre-global financial crisis levels.
Like most investment trusts, Fidelity Special Values can utilise gearing to enhance returns by adding to existing holdings or identifying new opportunities. It is currently 13 per cent geared.
Wright noted in this case it was due to the latter reason and referred to the increased number of opportunities available - and of better quality than usual.
This, he said, was especially relevant among small-caps and domestically-focused stocks such as specialist retailers and housing-related businesses – beneficiaries from current backdrop but still not valued accordingly.
Gearing level of Fidelity Special Situations & Special Values
Source: Fidelity International, Fidelity Special Situations and Special Values PLC , as at 28 February 2021.
In fact, throughout 2020 the gearing level increased to the highest levels of Wright’s tenure and Special Values increased its gearing limit to 25 per cent in October.
“We added to some very strong opportunities because things looked so good on the ground, fundamentally, as well as the valuations,” he said.
“There’s always been a lot of value in the UK, but because of the reasonably depressed consumer and business spending – fundamentals were somewhat soggy.”
He added that things on the ground looked better than they did pre-Covid.
“Company demand has held up and efficiency has increased, despite the fact the valuations are still very low,” said Wright.
It is well documented that the dual headwinds of Brexit and Covid have depressed UK valuations, but the uptake in M&A activity and takeovers show that things are changing.
Wright said: “The lack of international investment in the UK means that trends you’re seeing elsewhere, people have not been willing to play those in the UK.
“It’s not just a sectoral difference, it’s a general distrust of the UK market.”
But now a combination of low valuations and interest from foreign investors is converging to the UK’s benefit.
“UK equities remain undervalued in global context, which has not gone unnoticed by acquirers,” he said. “It makes sense to overseas corporates to buy UK PLC on the cheap.”
Performance of fund vs sector & benchmark over 1yr
Source: FE Analytics
Since this time last year, Fidelity Special Values has made 64.49 per cent, compared to 70.30 per cent for the average trust in the IT UK All Companies sector and 30.42 per cent for the FTSE All Share.
Value investing, the style pursued by Wright, has been out of favour for some time but has recently started to outperform growth.
However, pure value funds, as opposed to growth strategies or a blended approach of the two styles, are in a relative minority. For example, value strategies only account for 12 per cent of the IA UK All Companies sector’s total AUM.
Wright finished: “Being a value manager has always been a reasonably contrarian position, but it’s become a very contrarian position.
“If you want to take advantage of value trends in the UK market, do not buy a tracker and do not buy the average UK manager because you’ll get a blend and will miss out on the opportunities in the market today.”
Fidelity Special Values has ongoing charges of 0.98 per cent, is trading on a 1.2 per cent premium to net asset value (NAV) and yields 2.2 per cent.