amusement for us. His bike rack fell off and caused a massive crash of bicycles on his garage floor. And the following week, he fell off and basically broke his nose. Massive black eye.
Okay. It's supposed to be a healthy sport, but apparently not where I'm concerned.
There we are. Right, hello everyone and welcome to Taking Stock After the Bell, episode 55. Delighted to be joined by Alex Wright, the manager of Fidelity Special Values Investment Trust and the Fidelity Special Situations Funds.
Alex has been with Fidelity since 2001, beginning his career as a pan-European analyst, rotating across a number of different equity sectors. In 2007 he chose to focus on UK equities, initially as a small cap analyst, where he worked closely with Anthony Bolton and Sanjay Bajaj, the two previous managers of the Special Values Investment Trust. In December 2012, Alex took over the Fidelity Special Values Trust from Sanjay Bajaj, and in 2014 took over the running of the Fidelity Special Situations Fund. So a more than a 10-year track record. Alex graduated from Warwick University with a first-class honours degree in economics and is a CFA charter holder. Sanjay, Alex, welcome to, welcome to our fine new podcast studio where we are running it out for the first time today.
Thanks very much for having me. Great to be here.
Good. So, we've got, we've got a few slides and a few things to talk about. You know, as we were sort of discussing there in the intro, and it's not really been a terrible time for UK equities, is it? I mean, it's very different to what you sort of read in the papers. But I guess I'll sort of start off with a slightly more sort of taking a step back. I mean, you started your career in the early noughties as the dot-com bubble was blowing up, I guess, and I talk about this a bit because we started our careers slightly later, not, you know, around the same sort of time. Do you think that those early years starting out and what was going on in markets has impacted your sort of overall philosophy, or do you feel as though you have a philosophy and how has that been shaped by your sort of career progression, if you like?
Yeah, I think not really because obviously I wasn't here for sort of the run-up in the dot-com boom. And then sort of, yeah, as I started, you don't necessarily, you see what's sort of going on, like it was a very lively time. I actually started in the office September the 10th, 2004.
The day, no, sorry, the day before. Sorry. Yeah. Yeah. Yeah.
So it was clearly a volatile time in markets, but I think when you're first into the city you don't really know what's going on. You see what's happening in markets. So after you've been around for sort of four or five years and really have an idea of what's going on, that sort of shapes sort of much more about what's going on. So obviously we started managing money just before the GFC and that was a much, yeah, a much bigger experience. Yeah, I remember sort of the small cap fund started by the end of the first year. We only started March 1st. We were down 35% and we've beaten the index by 20% on the way.
So we had a sort of what you call a relatively good performance, but obviously a terrible absolute performance. So I think, yeah, a reminder of sort of that volatility can be very high, and that things can change very substantially is definitely something that's etched into my fund management career more so than sort of really being able to sort of call.
Yeah. The tech bubble looked like this. That happened a little bit before we got into the city and was very much unwinding by the time we were there.
Because I always sort of say to you, so when we started 05, 06, no one really talked about tech. It was just sort of a sector that just wasn't discussed. The only thing anyone wanted to discuss was Royal Bank of Scotland, BHP Billiton and Rio Tinto, which were the, and BRIC funds, which were the only things you ever wanted to buy, right?
Every portfolio had Tesco's in for some yield.
Yeah, four pound a share.
Good. No. And I think one of the more interesting things that we at Hargreave Hale have done with clients, advisers pretty regularly, and one thing that's sort of clear at the moment is all clients think the world's going to hell and they all look at the news both in the UK and internationally and they look at the portfolio and they go, 'Oh, it's done all right. Why is our portfolio doing so well despite the world?' I mean, what's your sort of view on the general malaise both in the UK economy and sort of slightly wider in terms of the geopolitics as well?
Yeah, big question. Easy question. Yeah. So, I think, so clearly geopolitics and its effect on economics is far larger than I guess investors have been used to over kind of the last 20 years because the last 20 years there weren't any meaningful wars. There was a reasonably sort of well understood sort of rules-based international system. There was a degree of predictability around sort of global economic policy and also the US's place as kind of the world's sort of economic and political policeman. Yeah, so clearly lots of things have changed.
And also through that as well there was the sort of, yeah, globalization, free trade, entry of China, huge disinflationary push from that, that massive urbanization of that population. And clearly all those previous trends are sort of gone into reverse.
Which I think unfortunately when you think very long term, when you're sort of talking on a sort of 10, 15 year view, that's probably going to mean a much lower growth, higher inflation, less good for financial assets outlook. Because deflation, lower interest rates generally led to higher asset prices and a really good economic environment. So I think that unfortunately is probably the long-term picture, that the incredibly good returns, 10% plus type returns you've been able to see from sort of portfolios is something people should not expect on average over the medium-term going forward because all of those factors are negative. Tariffs are negative for economic growth. Unpredictability is bad for economic growth. The sort of balkanization and separation of the world is bad for economic growth. So yeah, it is a little bit of a surprise that short-term asset markets have continued to be so strong because all of those long-term factors are negative compared to history.
And then do you think part of that's just that a lot of people running money have just been taught to buy the dip every time and sort of ignore a lot of what's going on, in a way they're just chasing themes?
Oh, most definitely. And I think also you can see that in things like retail participation, particularly in the US, the retail investor that has become a much more powerful force. Again, something that generally happens towards the end of booms or bubbles. So again, that's another negative sign, I would say.
On the flip side there, companies in the aggregate appear to be doing okay and I'm somewhat surprised at how kind of resilient they've been. I mean, do you sort of buy this view that company management and companies in general are a lot more agile and able to kind of dodge the metaphorical bullets? Pardon the pun.
Well, I think you've, yeah, obviously you've been through a lot of really hard tests over the last sort of 10 years, particularly if you're a UK company. It would have started with sort of Brexit and then you would have obviously had COVID, the mini budget. So there's been an awful lot of things that you've had to get used to. So again, I think companies have become increasingly good at contingency planning and dealing with big shocks that you wouldn't have expected would have been possible historically. So I think there is something that, yeah, you've sort of been battle-hardened and again I particularly like investing in those areas where sort of companies have had tough times and you can see how they've reacted to them and trying to avoid areas sort of that haven't had tough times because when a tough time turns up you're more likely to slip up if you haven't sort of been used to it. So I think that's a particular resilience of UK companies because we've had more than the average number of shocks, but globally we've had a decent number of shocks. I think it's fair.
And then do you think companies, if they're sort of battle-hardened and a little bit siege mentality, do you think they could be put in a position to be more optimistic and positive? And, you know, if we look at the UK economy, it's clearly not firing on all cylinders when fundamentally it seems fine. As I keep saying to, you know, consumer balance sheets are very strong, unemployment is relatively low. It's going up a little bit, but wage growth is decent. So, you know, fundamentally I sort of think that UK consumers and households are in good shape, but that's not translating into confidence and optimism and stuff.
Yeah, I think it's interesting. So, I think firms have got used to live with the shocks. But I think actually consumers have not really in terms of it's really consumers that have held back in the UK and also in Europe to be honest. So I think to a degree the inflation shocks have been bigger here because of the cost of energy in the UK and Europe and then the volatility of politics, the closer proximity of the Ukraine war to Europe than you've seen in the US has meant that consumers have really held back. Now, for me, that is a good basis to invest because you've got those strong balance sheets, high savings rates, lower credit card debt. That means if things just don't get worse that there is money to sort of spend and things could just not get worse and actually the picture then could be good. I think that's quite different from the US consumer which has really been shielded from some of those shocks. And you can see sort of debt levels are very high in the US. Consumer spending is very high. Credit card debt is high and defaults are rising.
Bottom end of the... savings rates have come down, have fallen a lot post-COVID. Because that's one of the things with the UK is how do we get UK consumers spending because at the moment they're just hoarding still, aren't they?
Yeah, that's definitely the case that consumers have the money to spend and indeed particularly at the low end because minimum wage has been growing strongly that the disposable income has been rising but consumers haven't been spending that. So I think it very much is a confidence thing.
Yeah. If we just sort of take a step back, you've been managing the Fidelity Special Values Trust since 2012 and we'll just flash this slide up now. We haven't quite yet got the TV working in here but maybe next time. Since presumably this is the start of your tenure in 2012, the net asset value of the trust is up 325% to the end of August compared to the FTSE All-Share up 167%. So some pretty decent outperformance there. If we, and we sort of touched on it in the sort of intro a little bit, but you know, if we zoom in a little bit more on the sort of what's happening here and now. I mean actually UK equities haven't been a terrible place to be. Year to date we've got the UK market and emerging markets up about 15% total return compared to a UK investor in the S&P 500 and the US equity index where the US market is only up about five or six percent mainly as a result of a kind of currency drag.
Is there any sort of optimism and, you know, you talk to a lot of investors and also a lot of companies, but, you know, is there a sort of feeling that maybe global investors are beginning to look at the UK a bit more and is that sort of something that we see will come through?
Well definitely, like ultimately like markets are a demand and supply. So for the markets to go up and outperform that means demand is higher than supply. So if we look at sort of flows into open-ended funds from UK investors...
Yeah, we've got that chart here.
Yeah, those are still negative. So while Special Sits is actually seeing some inflows for the first time in almost 20 years, which is great to see, that is very rare actually. There's only a handful of funds I would say of the 240 available in the UK that are actually getting inflows. Most UK investors are still divesting from the UK. So that means that someone is clearly coming in to fill that gap. And I think it is increasingly, yeah, global and US investors are looking to allocate some of the money they have from the US outside of the US. Actually, we just saw someone from our sister company yesterday and they were, the portfolios there are all positioned overweight ex-US because the valuation gap in the US is just very, very high compared to international markets. And also clearly I think while it's sort of the actions of the new Trump administration have somewhat spooked people outside of the US, they've particularly spooked investors in the US. The unpredictability, the sort of worries around Fed independence, institutional independence, how reliable data is when you've got 75% plus of your assets invested in that one market, that makes you think. So you don't need to move very much of your assets to international markets just because of the pure quantum. You just sort of look... the whole UK market I think is smaller than sort of some of the Mag 7 market caps. So it's a tiny amount of money needs to move to make quite a big difference.
And if you think clearly if you're a US investor, where is it most easy to sort of move some of your allocation? Clearly the UK with strong corporate governance, same language, good access to management. It's a much easier move than it is to other markets where it might be more difficult to invest, particularly in more mid and small cap companies. Sort of it's harder to see managements from smaller European companies, Japanese companies, emerging markets, etc.
And out of interest, do they... I think in the UK we get quite negative about what's going on. I guess from a political point of view, do the US investors not have those concerns? Sometimes I think we overly worry about the state of the country when actually it's all right. Sort of still going along as you say, it's got good corporate governance. We've got, you know, the best legal system in the world. Do they sort of want more international exposure? Are they happier with domestic focus?
So clearly the UK market is, 74% of the UK market isn't actually playing the UK economy. So the first thing is this: you can get international exposure in the UK market and actually potentially quite similar geographic exposure to some of those US companies but at a much lower valuation. So again that's a particularly easy trade. But then I think there is certainly in some of the larger companies that there are US investors investing in things like the UK banks clearly are a play on the UK market because the UK does have that very strong institutional system. They're obviously much maligned but a very sort of strong and rules-based sort of civil service and court system which I think is a bedrock of sort of serious investors.
Totally. Yeah. Yeah, I totally agree. And if we take a look at the UK market, you know, in terms of how the UK market has performed versus international, yes, we had that pretty dreadful period effectively 2015, 2016 through 2020. Got the chart here, chart four, Alex. But actually since 2020, the UK market has performed pretty much in line with the rest of the world. Yeah. Okay. It's been a little bit kind of up and down on a relative basis, but that just sort of, you know, speaks to this point. But despite that, the UK market still looks on a kind of very healthy valuation discount, doesn't it, to the rest of the world. We've got a chart here, chart six, of this is a sector neutral valuation. So this strips out the impact of kind of tech versus oil, showing that the UK market remains on a kind of 15, 20% discount to its, you know, typical average over the last 20, 25 years. I mean surely there has to be, you know, some sort of help in terms of the UK market and...
Yeah, definitely. And I suppose what's particularly pleasing to see is where the UK market sort of outperformed year to date, some of that valuation gap has actually started to close because as you can sort of see despite performance over the last five years being sort of somewhat in line, the valuation gap was actually further opening. So it was because earnings in the UK were sort of better that the market was performing in line, not the valuation gap was closing. Finally, you're starting to see a bit of that valuation gap close. I suppose the other thing that most people don't sort of reference when they sort of look at UK underperformance is just how expensive the UK market was back in 2015.
Yeah. Because it wasn't... it's only 10 years ago but actually the UK market and international markets been sort of a go-go place to be.
Because the sectors that sort of drove the markets up to the GFC and a bit beyond in terms of sort of mining commodities, the UK market has an awful lot of those and had a lot then and was attracting new IPOs, Glencore IPO, so again international businesses were listing here. So it's amazing how quickly sort of people forget that actually sort of it wasn't that long ago that the UK was the place where people really wanted to be and international investors very much flocking here.
Yeah. No, I hadn't thought that the UK market was quite expensive and of course 2015, 2016 was the start of the big oil price unwind, wasn't it? So that kind of undermined the earnings. And then also another good chart here in terms of valuation, it's a little bit simplistic perhaps, but the further down the market cap spectrum you go, the cheaper things get. So on your numbers current PE of the FTSE 250, the midcap index is about 12, 12 and a half times and then the small cap index is even a bit less than that in a sort of 11s I think. Looking at the chart here, is that sort of impacting or influencing where you're going in terms of new ideas?
Yeah, so it's interesting. We've used this chart, I think, for about a decade, and we've just had to sort of rename it because the UK market had been at a discount to its long-term average for pretty much that entire decade, and we've just seen the FTSE 100 just creep up to being marginally above its long-term average, but obviously that isn't reflected in the more mid and small cap part of the market. And to be honest, that has always been a bigger hunting ground for the funds. So about 60% of the assets are invested in mid and small caps.
Do you think are investors in the market expecting high earnings to grow faster over the next few years than they have done historically? They probably are slightly, aren't they?
I think actually well there's a bit of nuance here because obviously there's in the very short term because the pound's been so strong that's quite a drag on earnings. So earnings growth in the market this year is not particularly good. Actually we forecast at Fidelity on an aggregate basis earnings to be slightly negative in the UK market. First of all because of that pound drag on 75% of the market. But also because oil prices are down year on year. And also commodity prices are down year on year and then a few quite large stocks that have got down earnings. So when you're a big index weight like a sort of Diageo and your earnings are falling that's a drag on the market. If we look more sort of medium-term through 26 and 27, yeah, I think at Fidelity, we're expecting earnings growth to be somewhat similar to the long-term average. Okay, so around sort of five, 5%.
But obviously given that you've got a decent yield coming out of the market as well, like if you just don't see any movement in valuations, you can easily get the sort of long-term return of the market which is about sort of seven just from sort of that level of earnings growth and dividend yield. So I think yeah, earnings growth and valuation are all around sort of average for the UK market. So do I think the market has the ability to sort of compound at its long-term average about seven? Yeah, I definitely do.
Now, that is very different from what I'd expect from the US market. Yeah. Because there you've seen much higher compounding of returns over the last decade, but a lot of that has come from a substantial rerating.
Yeah. Sure. And concentration of the earnings growth as well in those.
Yes. So, it's become sort of riskier.
Yeah. Yeah. Yeah. Absolutely. And just on that there was a chart actually which piqued my interest in terms of the takeover activity has been, you know, and I'm not going to put this up because it's very wordy but got a sort of list here of stocks that, you know, are being taken private or have been bid for etc etc. Is that a theme that you think continues and as we sort of chatted in the intro that sort of, you know, the number of stocks being taken out of the market is a lot greater than the number of stocks coming into the market. Is that negative overall for the UK market and how do you sort of see that?
Well, it's a clear positive for performance for the fund and for the market as a whole because generally these stocks I think year to date it's about a 35% premium that we've seen on those takeovers. So generally I would say that you're getting fair value for those stocks. It's just they're trading below fair value in the market.
And I'd say that's been a clear trend that we've seen pretty much since 2021. Although interestingly this year we've already received more takeover bids in aggregate than we did for the whole of last year and we've still got a further three months to go. So from what was already a reasonably high level it's picked up to a higher level. I think what's strange is that in the past you would probably have thought this level of activity would generally rerate the market as a whole rather than just the specific stocks. But that hasn't happened and I think that's why therefore the takeovers continue because there is a big arbitrage between a US company buying a UK company or private companies buying a UK company because private companies generally also benchmark off the world's largest market which is the US. So what looks cheap to them is quite a long way ahead of where things are trading in the UK and very much that has generally continued to also be the theme and when you look at who the acquirers are it tends to be private equity and US corporates. There are a few UK corporate deals as well like the Bunzl or GKN deal and the Direct Line of Aviva deal but the majority would be private equity, US corporates.
Yeah, I mean I always think with sort of valuations at the levels they are if you're a US private equity house, it must be pretty easy to make the numbers add up in a spreadsheet to do a takeover at a 35% premium and give yourself a very nice IRR over the next five, seven, 10 years or whatever it is. And then, you know, are there any signs that the IPO market in the UK, you know, new companies, is there any signs that there is going to be any sort of renaissance or resurgence in the UK market anytime soon?
Well, so there are some signs. So there's I think currently there is a small IPO on the blocks and a small one happened but it's very much sort of at the margins. There has been more sign of things globally opening up. So there have been IPOs in Europe and the US and interestingly a lot of IPOs in Hong Kong. So I think globally there is an increasing opening up of the IPO market. I guess as a contrarian I don't generally actually take that as a particularly good sign because if you think about it, an IPO is sort of exactly the opposite of what I look for. It's sort of people trying to sort of paint a really good picture. It's an advantageous time to sell because markets have gone up, valuations are higher. So we don't as a rule do IPOs and indeed lots of IPOs are generally a bad sign. Like when did we last see a lot of IPOs in the UK? 2021 just around sort of the peak of the market before we saw a big sort of contraction in markets in 22.
