Next year will present a plethora of challenges but also opportunities, according to Fidelity International fund manager Alex Wright, who is positioning his portfolio accordingly.
He suggested 2022 will be similar to 2021 as supply chain issues cause inflation and therefore a greater threat of interest rate rises, which will be coupled with the ongoing potential for Covid flare ups.
This combination has had a significant impact on markets this year. So far in 2021 the FTSE All Share index has performed well on an absolute basis, returning 15.7% to investors, but it continues to struggle relative to other markets.
The MSCI World index of global stocks is up 20.2% year-to-date and is on pace to beat the UK market for the fourth year in a row, and the eighth year in the past decade.
Investors have voted with their feet. According to data from the Investment Association (IA), they have pulled £2.3bn from funds in the IA UK All Companies sector so far this year and £4.3bn from the IA UK Equity Income sector.
However, FE fundinfo Alpha Manager Wright, who runs the £3.1bn Fidelity Special Situations fund and the £936m Fidelity Special Values investment trust, said there were positives to look for in the UK.
His investment trust has been the best performer in the IT UK All Companies sector this year, returning 25.2%, while the fund has made 20.9% – a top-quartile return in the IA UK All Companies sector.
Total return of funds vs index in 2021
Source: FE Analytics
Wright said UK equities were “significantly undervalued” compared with global markets and “reasonably valued” in absolute terms. A by-product of this has been the rise in mergers and acquisitions (M&A), which has been a key contributor to performance for Wright’s funds this year.
“We are likely to see more bids if valuation discounts compared with overseas companies do not close,” said Wright. He added that although the market has been cheap for five years, company fundamentals have now strengthened.
“The removal of the Brexit uncertainty and the country’s swift vaccination rollout have contributed to the improved outlook. Meanwhile, consumers who have been unable to spend during the lockdowns have extra savings,” he noted, which he said should help to stimulate the economy.
Looking ahead to next year, he said Covid “shudders” should work their way through the economy, although he conceded that new variants such as Omicron were a concern.
Meanwhile, rising input costs were becoming an issue, from higher inflation caused by supply chain problems, as well as the soaring price of raw materials, energy and labour.
“These factors are going to lead to rising margin pressure on some industries and individual businesses,” he said. “This is a key topic in our conversations with companies, as we try to assess how they are affected and their ability to pass the extra costs on to their customers.”
Due to these supply constraints and cost inflation, Wright said he had reduced his exposure to areas faced with meaningful rises in input costs, such as UK housebuilders.
“A recent update by builders’ merchant Travis Perkins highlighted an 11% rise in the cost of building materials in the third quarter alone,” he said. The manager has also sold out of Restaurant Group for similar reasons.
He is “meaningfully underweight” consumer staples, which he described as expensively valued, as well as global mining stocks, which have been bid up in recent months.
Instead he has focused on areas where the pandemic has accelerated the pace of change, both at an individual company level and also across entire industries. He said the lockdowns have allowed faster restructuring as companies have used the downtime to accelerate changes, which has led to cost savings.
He has backed Inchcape and Halfords, with the latter “well positioned to take advantage of supply constraints in cars and bikes”. Vehicle rental business Redde Northgate also got Wright’s seal of approval.
Another area well placed to benefit from inflation and higher interest rates is financials, as bank margins are directly linked to higher rates.
Here, Wright has maintained his exposure to life insurers and banks. “Indeed, our largest sector exposure is to life insurers, which remain cheaply valued, despite strong balance sheets, positive earnings outlooks (thanks to a healthy demand for protection products, bulk annuities and pension de-risking) and attractive dividends,” he said.