Welcome back to the Investing on the Go podcast, brought to you by Fund Calibre. Geopolitical tensions have once again taken center stage, reshaping the outlook for markets and challenging investors. Today's guest shares how shifting sentiment is impacting UK equities. I'm Chris Salley, and today we're joined by Alex Wright, manager of the Elite Rated Fidelity Special Values Trust. Alex, once again, thank you very much for joining us today.
No problem. Thanks very much for having me.
No problem. So, as you all know, I probably three, four weeks ago had some questions for you nicely set up, and then the world has changed quite a lot since then. So there's only one place to start, and that is with this geopolitical uncertainty and what is happening in the world now and how it impacts everything everywhere. So I guess let's start with you and your focus on the UK and just how you've sort of taken on board these changes in terms of possible impacts on your portfolio and how you've sort of managed to take that on board.
Yeah, so unfortunately, Chris, you're right. The outlook for the stock market is materially worse than it was only a month ago, before Iran, and that's irrespective of what happens from here. I think it's very difficult to predict exactly how peace talks and deals will go from here, and we're not trying to do that. But what we are looking at is what's happened and what it means for the world, and I guess particularly here it's all about what happens to energy prices and just the fact that the straits have been closed for a month, and that has materially affected the oil price and will do over the immediate term in terms of 12 to 24 months, because you sort of run down stocks and also you've damaged key infrastructure. So even if everything went back to how it was a month ago right now, you wouldn't get back to where we were previously in terms of stocks and production for at least 18 months, if not 24 months. And that's particularly the case in gas, because unfortunately the damage done to the gas infrastructure of Pearl LNG, the Shell assets in Qatar. And so that does mean that energy bills are going to go up for UK consumers, and they're going to stay up for probably at least 12 to 18 months, which is not good news for the amount of money people have got in their pocket and also for inflation and therefore interest rates. So certainly for more cyclical stocks, that is a clear negative, particularly for the smaller part of the market. And so I've been surprised, to be honest, especially with the rebounds that we've seen more recently, that you haven't seen a worse market outcome, because these effects are obviously in place now, and obviously if we don't get a ceasefire or deal, they'll just get worse. And so there's clear risk, I think, to stock markets as a whole from current levels, and we have reduced our net exposure because of that, so quite a lot. So we would have been about 102% invested, and we're more like 94% invested. So from a geared situation, borrowing money to invest in stocks, we now have the effective 6% cash in the fund.
Okay. Just a couple of quick questions to follow up on that. Firstly, when you said you were surprised with certain things, is it that people have been buying the dip that you've been surprised at? Is that what you're seeing?
Yeah, I think because of the famous taco trade, the fact that has largely reversed pretty much everything he's talked about to start with, and then clearly there are signs of him doing that here as well. But people have sort of been ignoring what's going on and thinking, 'Oh, we'll go largely back to where it was.' I think this is different because, as I sort of said, those stocks are being run down and the assets have been damaged. So whatever happens from here, we are not going back to where we were before. And I think the market's a bit complacent about that.
Okay. Did you want to talk a bit more about some of those positions you have sort of been looking at more recently? I saw some stuff focusing on the likes of Glencore for its coal exposure, a bit more on reduced copper-focused positions. Just maybe talk a bit more in detail about a couple of those, please, and how they help you to manage as best you can this uncertainty. Obviously, you can't do it completely because you don't have a crystal ball, but you can try to do what you can, I guess, is what I'm saying.
Yeah, so I think we need to be honest with investors. We are an equity fund, so you're going to get equity market exposure here. So if equity markets go down, the fund's going to go down. And also, because we're mid and small cap buyers, we've got 60% of the fund there, that tends to be more cyclical. So actually in a falling market, we would generally not just go down, but go down more than the market. And indeed, that has been the case so far this year. We have gone down more than a falling market, although we've actually only really gone down probably in line with other funds, which actually has been a positive result compared to the shape of the portfolio. And I think part of that is actually what investors have done is they've sold off some of the positions that had previously done well, even if they were somewhat defensive positions. And so the fact that we've exited Rolls-Royce, which clearly is a bit of a defense play, people might think that would help hold up in this environment. Actually, it's underperformed because it was so well owned. And so actually what we've looked to do at the margin is sell some of the stocks that have done well, so including actually some of the gold names as well as some of the copper names. Reinvested that a bit more into Glencore, which while it still has copper exposure also has coal, which obviously is a bit of an energy hedge and also a geopolitical hedge, because coal is produced in many more places than gas in terms of the energy market. So I think the value of Glencore on a medium term has sort of gone up. And I think it's these more out-of-the-way and less well-known places, because the thing is, generally defensive assets that you might go to, like utilities or healthcare or defense stocks or even oil stocks, have all done well previously. So there isn't the natural places to hide today. So I think it's quite tricky in the market.
With the defense stocks, I mean, they were sort of very much the place to be, almost FOMO at one stage, but there is this narrative starting to come out of, you know, you can't really hide in them because they're so expensive. How significantly underweight are you now? What's your view, because you kind of don't want to miss them completely, I guess.
Well, so defense has been an outlier. We've owned every defense company quoted in the UK over the last 10 years, and we were super excited about this space 10 years ago when everyone absolutely hated it. But our exposure is probably the lowest it's ever been today because the sector's done so well, and also a number of the names we owned got taken out. So Meggitt got taken out, Chemring did really well. We sold out of Cohort, big profits, sold out of Kinetic, big profits. And today the biggest stocks are sort of BAE is up to 3% of the UK index. Whereas when you look at our pure defense exposure, it's 1% in Babcock, again a name that's more than tripled since we bought it, and we've meaningfully sold down. And Serco is another defense name that we've owned for a long time. Actually, it wasn't seen as a defense stock 10 years ago, because in fact defense was quite small, but now it's almost 60% of turnover. But again, that's been something at the margin we've been reducing rather than buying more of, because it has done well. So again, I think that's it. These names, Serco's held up pretty well in this downturn, but actually Babcock has come off, because it was so well owned. So the natural hiding places have proven to be good differentiators. And obviously, gold has sold off quite meaningfully since the start of the conflict. So again, showing just how difficult it is to insulate yourself here, because some of those traditional safe havens have done really well over the last year.
One area that is of interest, which I don't know if you'd call it a safe haven, but it's certainly done well recently, is those oil majors as a result of what's been happening in the strait with it being closed for a prolonged period. Is that an area that you're also wary of at the moment, given the prices, or...
Yeah, so again, oil is something we had a lot of in the fund in 2020, when the oil price went negative. But obviously things started getting better through 2021, and obviously through 2022 those stocks did incredibly well with Russia-Ukraine, and we started reducing then. We've had a small weight since then, because I think having moved from a prior status with the ESG bubble in 2018-2019, these stocks have become much more acceptable to invest in. But actually, when you look at what you've got in the UK in terms of Shell and BP, both of those companies, particularly BP, have had strategic issues in terms of flip-flopping on new energies, cutting their dividends, reinvesting at low returns. And they've sort of stopped really spending on exploration. So the issue is that those are declining assets at reasonably high valuations, certainly reflecting a long-term oil price reasonably above our view of $65 long-term oil. So there will obviously be some short-term gains while oil is above those levels, but you're sort of paying for oil being permanently above. So while you might see oil here for 12 or 24 months, we don't think you will on a 3-to-5-year view.
Yeah, I was kind of thinking, like, I mean, I've just spoken to a multi-asset manager who's incredibly miserable, and he was sort of saying, 'What if the world's changed forever? What if Iran controls this with China? What's coming out of that strait?' Can you think about things like that long-term, or do you just have to look at the fundamentals of the stock now going into the medium term?
Yeah, so you think about the range of outcomes. So that obviously is a potential bad outcome. That would just be bad for everybody. If oil stays at over $100 and Iran has permanent control, that would generate a global recession. And so in that case, you don't really want to be in stocks. And when you look at, we've got 6% of the fund in oil, it's in Total and a couple of smaller companies. They would do well, but the other 90% of the portfolio would do badly. So that is a scenario that you have to consider, but it's a bad scenario for everybody. Bigger things to worry about. But also, I think you need to think about that's such a bad scenario, just how much capital the US would spend to stop that occurring is probably also quite high.
