Fidelity Special Values PLC 2025 AGM

Brilliant. Well, thanks very much for that kind introduction, Dean, and yeah, it's great to be able to speak to you all today. Particularly after another year of strong performance, which does mark, as Dean said, probably the fourth year in a row of strong performance for the trust. So if we just look at that performance versus the market, I think it's particularly interesting that we've had a very strong performance versus the benchmark despite the fact, actually, it's not been a particularly great area for mid and small caps, which is an area the trust really focuses on. So about 60% of assets are invested in mid and smaller companies, and compared to the benchmark return of 12%, they actually only returned about 6% in the year. And so that was a big drag on performance. So actually being able to outperform the index as a whole demonstrates the strong stock picking within the trust, particularly in the larger companies in the UK over the last 12 months. And obviously that continues the strong track record that we show here, sort of over 10 years since I took over the trust all the way back in 2012.

If we talk about sort of what contributed to that strong performance, it's great to see that actually it was quite broad-based across a number of companies. So one area that we've been heavily invested in, and about 15% of the trust is still invested in today, is banks. And indeed, Standard Chartered is one of the top three positions today, and we have large positions in NatWest and AIB. We've also added Lloyds in the last year. And those three names in particular have been very strong contributors to performance. I think encouragingly, it's mainly been on the back of really strong earnings and dividends coming out of the banks, and the rating for that sector as a whole is still quite low. So maybe not the six to seven times earnings that we saw a couple of years ago, but still only eight to nine times earnings, a lot cheaper than the UK market still, which is on about 14 times forward PE.

If we then look at defense, that is an area that the fund has had a lot of exposure to over time, something we've been invested in the whole sort of 10 years plus. Clearly, 10 years ago, defense was not a very sexy sector that other investors were interested in, but increasingly it is so. And we have actually been reducing our exposure to defense over time because of that. But our remaining holdings in Babcock and Chemring were particularly strong performers in the year. Babcock year to date actually more than doubled, Chemring over a 50% return, as clearly defense is a lot more important and there's been big stock-specific stories around those companies as well.

M&A, which has been a driver of performance over time, has continued to be so in the year. These three positions, Direct Line, Bakkavor, and Just Eat, quite large in the portfolio, sort of one and a half to two percent positions, and so their takeovers have been particularly meaningful for performance. But we've had a number of other takeovers as well. Indeed, I think unusually, actually, Direct Line and Bakkavor were taken over by UK companies, and indeed we've continued to run positions in the acquirers of those businesses. So Aviva bought Direct Line, Bakkavor bought by Greencore, Just Eat has been bought by a Canadian rival, Brookfield.

Obviously, not everything has worked in the last 12 months, and there's always detractors. I'd say the industrials and consumer cyclicals have continued to be weak over the last 12 months, and certainly we've seen the effect of that. Also, some specific market share losses at WPP and IG Design, which were some of the biggest detractors. Two of the more detracting industrial positions, Coats and Keller. These we've still made very good money in over the longer term. We've owned these stocks over sort of three to five years, and we've still done well over time, but they've given back some of their returns in the last year as there have been fears over tariffs, which actually haven't played out in the earnings of either of these companies. So there has been a bit of a more recent rebound there. And then we've had some stock-specific management issues, both Costain and Wood, changes in management there, and indeed sort of Wood being taken over, but at a very low price. So indeed, in totality, Wood is one of the biggest detractors where we clearly got the story wrong in terms of both the demand outlook and also the cash generation of that business, which was much, much worse than we were anticipating.

If we then look at how that translates into the long-term performance, so again, we're very proud of being able to continue this long-term track record of outperforming the index by almost four percent per annum, and indeed the returns of the fund this year are not that far from the long-term average of twelve. So I do think that the ongoing ability to add value over the UK market is something that we've been consistently able to demonstrate, and from here we'd very much expect to be able to continue to do that through the cycle going forwards.

I think also what's interesting is we talk about there's an awful lot of focus on sort of the US being the market where a lot of people are investing and putting assets in. But actually, over the last five years, Special Values has been able to handsomely outperform not just the UK market but also the US market. So while we might not have the excitement of some of the sort of big AI stories that everyone's talking about in investing, actually we've been able to produce sort of better returns than the US in this vehicle over the last five years. And so again, there's a lot of negative speak about the UK economy and the UK market, but in active management there really is an awful lot of value to be had here and the ability to produce very good returns. And so this is a chart we're particularly sort of proud of, that even versus what's regarded as the world's sort of best-performing market, the US, we've been able to handsomely outperform that over the last time period.

In terms of what then we've been doing within the portfolio, there's always active additions and disposals. We have moved around some of the financials holdings, selling out of Barclays after very strong gains, also selling out of Phoenix, which had been a long-standing position and again over time had been a very good contributor to performance. GSK was always a smaller position but also had done reasonably well, so we sold out of that. Bid completions are obviously part of it as well. So these are names that we've been selling down as these bids have come through. In terms of new areas where we've been putting capital, we did consolidate some of the oil holdings, selling out of Shell and Slumberger, reducing energy, but introducing a Total position around this time last year, particularly around sort of some of the issues that were affecting the French stock market because of the governmental problems there. That affected pretty much every large-cap French stock, even though Total only has about six or seven percent of its earnings from France itself. It's a truly global oil major in the same way that BP or Shell is, and we think that that is a more attractive play, having continued to invest in oil and gas through COVID, did not cut the dividend in COVID, and has a very good pipeline of new oil and gas projects going forward.

We also used some of the Barclays proceeds to invest in Lloyds, a name that we haven't had in the portfolio for a number of years, where we did have previously particular concerns around the motor financing case. As it became clear that that case was sort of coming to a conclusion and we thought was likely to see sort of lower costs and maybe the market was baking in, Lloyds looked at an attractive proposition within the banking space. Business is very similar to NatWest, which is an existing holding, both trading on, yeah, sort of eight to nine times forward earnings with very strong dividend yields.

Then we also initiated a position in Glencore. That's something that we've never owned before, and mining is something where we probably have the smallest underweight we've ever had. So I've always found it difficult to see value in iron ore companies, but actually when you go to more esoteric metals, I think there is some value. Glencore is primarily a copper play, its largest metal. It does also have significant thermal and coking coal. And we added a position in there. We do also have some positions in some other copper miners and a couple of smaller-cap gold miners that have been strong contributors to performance over the last 12 months. We've actually been reducing gold a little bit at the margin.

Other big positions that were smaller 12 months ago that we've built up. So Smith & Nephew is something we just started buying in the previous financial year but made into about a two and a half percent position as we see a sort of stock-specific turnaround happening there in the US or business, and indeed that has started to come through. BAT, again, we started buying over 12 months ago but made a much bigger, closer to three percent position now, and that's really around much better enforcement by the FDA in the US of illegal vapes, which had really been taking market share, taken up to 60% of the market in the US and really hurt BAT's business. The enforcement measures being put in place by the new administration, particularly at the border, because most of this product comes from China, are really helping, as well as the very strong growth of modern oral in the US. So that is a product that looks much more like chewing gum that just delivers nicotine in a much safer way, clearly, than smoking. That product is growing very strongly in the US and increasingly has more support, and obviously is a product famously being used sort of by RFK even during sort of speeches in the Houses of Representatives.

We've also looked at property. So property has been a good sector. We had the completion of the Warehouse REIT deal in the year, and we've recycled some of that into a much bigger position in Derwent London, which is prime central London offices. So there clearly has been a change in trend with more working from home. But in fact, if you've got very good prime office space, that is now in high demand as firms are increasingly getting employees to come back and want to offer a better office environment for that. Derwent is one of the companies I think well placed for that trend.

If you then look how that affects the sort of makeup of the portfolio, you can see here sort of super sectors that we divide the UK market into: sort of financials, resources, other GDP sensitives, and defensives. We're still overweight financials, but at the margin that's reduced a bit as we've been taking some profit, particularly in those insurance names that have done well. Defensives, where we were overweight, actually we've been reducing some of those because they have been strong. So particularly Imperial was a name that we've been reducing during the year. GSK, a name we sold out of that after it had done well. That part of the market in general has been pretty strong this year.

Whereas other GDP sensitives have been somewhat weak. And there really has been a sort of consumer and industrial recession which very much continued this year as it's done for the last two years. So that's an area we've been leaning more into. And then you can see our resources is still underweight but less so. That's primarily those additions in mining. Whereas oil, which is a large sector in the UK, we continue to be underweight. We do have some holdings like Total. But overall we do think that the supply-demand situation in oil right now, there is a lot of supply and so the oil price has been falling. And again, while we don't see a lot of downside in the oil price, similarly we don't see that much upside in the oil price over the next 12 months.

This shows absolute sector positioning. So while the other slide was sort of relative to the bench, this shows absolutely how much money is invested in each area. So you can see financials still a very large weight at sort of 27% of the portfolio. Industrials, which is a very broad sector, still very large in the portfolio, but that's both some of these more cyclical industrials like an RS Group that we've added in the year to the more defensive ones like a Babcock or a Chemring that we talked about in defense.

The key areas where we have low exposure compared to the market is pharmaceuticals. So again, that's quite large, and while we do have a position in Astra, that's a very large benchmark weight. Aerospace and defense is actually now a very large underweight. So while we do own some defense names, we don't own BAE or Rolls-Royce, which would be the big contributors here. We sold out of the Rolls-Royce position recently after booking about a 300% gain. That stock's done really well. No longer meets our valuation criteria.

Areas that have been creeping up in terms of overweight, specialty retail. That's something that we've increased our position in, particularly around the purchase of Frasers Group, which was something we were buying earlier in the year, a company that used to be called Sports Direct. That's a big position. We also own Halfords and Moonpig, some other retail names in that area.

As I mentioned before, the market cap exposure. So we're still very overweight mid and small caps. That's very much a structural bias because there's more names available in the UK market in that area where we think we get more of an analytical edge with the Fidelity research team. So overweight the part of the market below five billion and funding that by being underweight large caps.

And today I think also that's backed up by sort of valuations. So over the very long term, you can see sort of most parts of the market trade on similar multiples. Today it's interesting that the FTSE 100 now trades at a very slight premium to its long-term average. First time that that's occurred for about ten years, that actually UK large-cap stocks are more expensive than their long-term history. But that isn't the case for more mid and smaller-cap companies which have lagged. So again, at the margin, we always have a lot of the fund there, but we have been buying a bit more into these mid and small caps where there's more cheaper valuations and I think more opportunity.

If we then compare the UK market to the rest of the world, so yes, the UK market's done particularly well this year, a sort of over 20% return. And so compared to its own history, the UK no longer looks that cheap, but actually compared to international markets, it still looks very cheap. So you can see the UK market at about 14 times earnings compared to the US at 24. A huge valuation gap and also a gap to other developed markets like Europe, Japan, or Asia Pacific. If we then compare sector neutral, which I think is more important, on the left-hand side of the chart you can sort of see that it isn't just because the sectors in the UK are different versus global indices, i.e. far less technology in the UK. Actually on a stock-like-for-like sector basis, the market continues to be cheap. Now this is the first year sort of for almost ten years you've actually started to see that valuation gap close a bit. So from sort of a 30% valuation gap now maybe a sort of 23-24% valuation gap, but it's still a gap. So it's nice to see it starting to close, but there's obviously further to go to sort of the long-term average of more like a sort of 12% discount versus global markets, which is the very long sort of 20-year history.

If we then look at the characteristics of the fund compared to the market, you can sort of see a decent discount in the portfolio compared to the market as a whole. So the market trading just under 14 times. We're at 11 and a half. And we're not doing that by taking more risk. So the debt to EBITDA is lower than the market. And then if you importantly look at what we think the profit growth from the portfolio can be going forward, that we're forecasting double-digit profit growth for the portfolio. So actually if you think about the long-term returns of 12 or indeed this year's returns of sort of 14, we don't actually need a re-rating of the portfolio to deliver that because we're seeing profit growth forecasts of sort of 13%, a dividend yield of the underlying portfolio companies of about three. So if we just hold that rating, actually we're going to see that sort of 12% type return. Now obviously these are forecasts going forward for 26 and 27. So it is important that these are delivered, and that's where all the hard work at Fidelity goes into making sure that companies do produce the profits that we're forecasting for them to do. If we have worries about that, recycling into names where we can see that profit being delivered. And clearly, as things stand, our forecast for growth in the portfolio is much higher than it is for the market as a whole, where we're seeing more like sort of 5 to 7% profit growth. And obviously that is also from higher valuations for the market as a starting point too.

We touched a bit on M&A earlier, but sort of to focus in on sort of what specifically happened. You can see that we've had slightly more bids this year. So this was sort of to October. In terms of the number of companies, the biggest contributors within those would have been sort of Bakkavor and Just Eat, which were the bigger positions, but we've had a number of smaller companies as well. And I think very much this trend, as it's been a big trend for the last three years, is likely to continue while you see the big valuation gap of the UK compared to other markets, because often these are sort of foreign acquirers that are looking to take advantage of the cheap valuation of the UK.

Interestingly, the Sika bid which is live today, a company that's described themselves as a twin to Sika, was trading on about nine times earnings whereas Sika was trading at 20 times earnings, and they've described themselves as a very similar business, which is crazy. So it sort of shows Swiss investors are willing to pay a very different price for effectively the same company, similar end markets, pan-European with some Asian and US exposure. And so that sort of low valuation of UK assets compared to peers, even within Europe, very much continues.

So I think to sum up before we go to questions, I think it's been a really great year for UK equities. Indeed, this is a culmination of several years of good performance for the trust, but they are still cheap versus other markets, and I think absolutely the portfolio still looks interesting and particularly relative to other opportunities out there which look expensive. It still looks an attractive place to be. The large divergence in performance of different stocks is interesting as well because that gives you the possibility to dramatically outperform the underlying markets with an active approach compared to sort of getting the total return of the market. And again, we continue to think that our performance will be benefiting from a continuation of strong dividends, good buybacks, and that strong M&A activity. And you're able to get the portfolio at a decent discount to the UK market overall. Great.

Yeah. So other things being equal, declining interest rates are generally a negative for banks. And indeed there were a lot of fears when you got to the sort of the peak of interest rates about two years ago about what a declining interest rate environment would mean for the banks because obviously it's been a very long time actually since we've seen a sort of declining interest rate environment because you were obviously in a zero interest rate environment for a very long time and then we had the big increases. I think what's interesting is that I think a lot of people mistake sort of the different changes in interest rates and what they mean for the banks. So banks were clearly a very poor investment for a long period after the global financial crisis when we had extremely low levels of interest rates. And why was that? Well, if you think about it, you can charge for loans, but generally you can't sort of charge people to sort of put deposits in the bank. And so if your interest rates are almost zero, the worst you can sort of give someone is zero. So the spreads that you're able to make between loans and deposits at near-zero interest rates are incredibly low. As interest rates go up, that spread opens up. And then as interest rates go down, if as long as they stay away from zero, the deposit rates come down with the loan rates. So actually margins don't move very much at normal interest rate levels. As you get to very low levels, sort of sub one percent, that's when you get the real margin squeeze, and that's very much what you've seen play out. So you have seen, particularly in Europe, so this would be a good case for AIB, that net interest income and net interest margins have come off somewhat this year. So profits were down for AIB this year as European interest rates went from four percent to two percent. But they weren't anywhere near down as much as people may have thought based on sort of the effect of rates going from zero to four, because it's that sort of two to zero which has a very negative effect. So I think going forward, as long as interest rates stay within a normal bound, not below one percent, the banks can still earn very good margins. And that is what you're seeing actually the market sort of baking in now, the fact that you are going to be able to see ROE stay at this above fifteen percent level. So an ROE that's better than the UK market. That is something that people ten years ago never would have expected to be the case, but was very much what we thought would be the case in this normal interest rate environment.

So obviously if you think about GDP growth, obviously a faster growing population has a benefit to the absolute level of GDP growth. Although I would say actually if you look at sort of native demographics in the US, they're not massively stronger than Europe. So historically there has been more immigration into the US, which is obviously being cut back. So population growth in the US is not going to be growing at that kind of level going forward under the current immigration rules in the US. And it indeed may actually go below European growth levels in the short term. Also, those are very long-term trends as well in terms of sort of GDP growth and population, and it doesn't actually have that big effect on stock market returns. So again, if you look at the correlation of stock market returns to GDP growth in a country, there's almost no correlation historically. So I don't believe that a faster growing US population is actually benefiting the US stock market. It's other things that have benefited the US stock market. I would say particularly obviously innovation and AI has benefited the US stock market. Population growth actually doesn't have that, there is no causality between population growth and local stock market returns. And you can sort of see that particularly in terms of if you look at GDP growth driven by population. Obviously, China has had a very strong GDP growth rate, but its stock market has been a very poor performer. Now, that GDP growth has not been driven by population because China's population is not growing fast. But I think those metrics don't really have a particular effect on stock market returns.

Is the US economy more dynamic than the UK economy? It depends what you mean by dynamic. So the US is a larger economy, and that confers some particular benefits in terms of your ability to scale across a much larger population, and particularly in a world where winner takes most in a number of online sectors, clearly the largest companies do the best. Now the US has done very well at scaling that. Obviously China has some of those characteristics also, and they have not managed to sort of play those. So it's not just those sort of inbuilt large economy benefits. You have to have other things working for you as well.

We will take that as an action and we will make sure that we have hard copies available for shareholders. We've got a few actually here, so a few of you will be able to have a hard copy today, but next year we'll make sure that everybody who attends can take a hard copy with them. But thank you for the feedback. We have a question here.

Yeah, I think you're misreading that because we haven't used CFD in that case.

Yeah. So the CFDs, that's how we use the gearing in the trust. So we tend to use CFDs on a broad number of companies. And we basically do that so that we have a diversified borrowing base and that minimizes the cost of the borrowing. So it's much cheaper than using a bank loan and it's also much more flexible. So we only use it when we need it. Obviously, we do realize in the annual report that could create slightly strange presentational appearances because it shows obviously the profit and loss on the position, but it's not the total profit and loss. It's only since we regeared the CFD because sometimes we do change providers for cost reasons and that resets the P&L.

Well, so again, they don't have a set maturity date, but again, we would tend to do that if effectively it becomes cheaper to use another provider. And again, unlike stocks and shares, when you obviously trade them, you have to pay stamp duty. CFDs, you don't, which is another advantage of having some of the CFDs in the portfolio. And so it is pretty much costless to switch between providers, which is why we do so when there's a cheaper option available.

So I think on that point, there are many companies with a high degree of correlation in the portfolio. So we definitely do think about that. So clearly the correlation of stocks in some areas is particularly high. So like oil would be a great example. BP and Shell, those stocks would move under normal circumstances very closely together. Similarly, sort of house builders, there'd be five to seven stocks in the UK market that mainly move on what's happening to house prices. So some areas there'll be high correlation, others clearly like support services where businesses are doing incredibly different things, there'll be much lower correlation. And so that is something we think about very carefully and we think about that particularly in the quarterly review process that we have at Fidelity where we look at sort of things like tracking error, where is the risk in the portfolio being generated, what is the correlation between the stocks, what is the beta to the market, because particularly on an absolute basis, clearly stocks, if the market goes down, the average stock will go down, so that there's a reasonable degree of correlation between the companies on an absolute basis as well.

The resources that we have in the analyst team is, I think, one of Fidelity's key competitive advantages. So, you're right, we can pick stocks within a sector where they're covered by a sector analyst who has sort of deep sector expertise. So, a great example is healthcare. When we talk to Emma, she covers only healthcare companies. She covers the global healthcare sector. So, she has a very clear view of which drugs are doing well, how a development pipeline is looking compared to peers and can sort of say how attractive an Astra is compared to a Roche compared to a J&J compared to a Lilly. And we have about 40 people covering stocks listed in the European market and then we have well over a hundred people covering the rest of the globe as well. So we have a team not just based here in London, we have a team in Canada, a team in Hong Kong, a team in Tokyo and some other offices, Singapore also. So we get a real global picture of what's going on, which obviously with the UK market having 75% of its earnings not from the UK is particularly important.

So the beta of the portfolio, I think, is slightly below one today. So about sort of 0.98. And we're generally comfortable within a band of about sort of 0.8 to 1.2. Sometimes when the market is very volatile, the beta of the portfolio may move substantially. So for example, sort of within COVID, the beta of the portfolio moved up sort of to more like 1.15. Outside of those bands, that's where we become less comfortable because again, while markets move up over time, we never want to be too extreme on either side because we believe it's the individual stocks that we want to power performance rather than it sort of being a bet on a directional market.

So obviously what we want to do is have everything in the portfolio be stock specific and we'd like to not take big sector bets because again I think my ability to call what happens to a sector is much weaker than what happens to an individual stock, like my ability to call what happens to the market as a whole is weaker than sectors and weaker than stocks. So I would be most comfortable if all these lines were at zero. Yeah, so that would be ideal and all the risk would be stock specific, not sectoral. Now that being said, if the market really loves a sector and really hates another sector, we're not going to own a really expensive sector that the market loves just to control the risk and get our sector bets down. And I think that was very much the case if you went back to 2014. If you think about, so when we were taking on Special Sits, we'd been on Special Values for a couple of years. It was all about the sort of the search for yield. Bond proxy stocks were incredibly expensive. Tobacco companies were expensive. Utility companies were expensive. Pharma companies were expensive. So it's very difficult to find any good value defensive stocks at that point. Whereas people absolutely hated banks. The economy had been sort of weak after the initial recovery from the GFC. So actually financials and economically sensitive stocks were really, really cheap and so the portfolio was very skewed at that point. Now to me that was an uncomfortable position to be in because if there had been a big global recession at that point the portfolio would have performed very poorly because we didn't have any defensive stocks and we were very overweight GDP sensitive and financials. Now obviously what's sort of happened since then is obviously people have become a bit less interested in bond proxy type stocks, they've been chasing growth, so some of the sort of more highly rated stocks in the market. So I think today there are lots of interesting defensive companies as well as some of the more cyclical companies. It's actually only really been resources that as a whole I've struggled to find value in because I've found it's been difficult to sort of see value in the big iron ore stocks although they've actually become smaller in the index. And then oil is quite a big sector. And I've struggled to sort of want to have more than 10% of the portfolio in oil when effectively that is just a bet on the oil price which again is quite difficult to call. So even when we've really liked oil in sort of end of 2015, 2020, we've never really had more than 10% in oil. So we've never really been an overweight oil in the portfolio over the whole time that I've run the strategy.