UK investment trust extends winning streak

Against a positive backdrop for UK markets, Fidelity Special Values Ord (LSE:FSV) was meaningfully ahead of the FTSE-All Share benchmark, as well as the small/mid segments of the market.

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Over its financial year to 31 August 2024 the portfolio, which invests across the UK market, returned 24.1% on a net asset value (NAV) basis and 24.3% on a share price basis.

In the same period, the FTSE All-Share rose 17%, the FTSE 250 delivered 17.3%, while the FTSE Small Cap advanced by 18.7%.

The portfolio derived outperformance from a variety of sectors and businesses, and manager Alex Wright reflected on strong earnings overall across portfolio companies and optimistic trading outlooks.

The numbers in detail (for financial year to 31 August 2024)

Share Price Return: +24.3%
Net Asset Value (NAV) Return: +24.1%
Benchmark Return (FTSE All Share): +17%
Premium/Discount: 8.8% (vs 8.9% in prior year)
Dividend: 9.54p (vs 8.80p in prior year)
Gearing: 7.9% (vs 6.5% in prior year)

Outlook

The manager’s outlook is optimistic, noting the opportunity posed by diverging performance across different sectors of the market.

The UK’s recent performance has been robust but, nonetheless, valuations are still low vs history and vs other regions. That offers scope for investors to uncover companies with strong returns on capital and resilient earnings at favourable prices.

Portfolio

Areas of perceived weakness have provided ideas for Wright and deputy manager Jonathan Winton across many corners of the market. Outflows from the small end of the index encouraged the team to add to “prior growth darlings” in Moonpig Group Ordinary Shares (LSE:MOON) and Team Internet Group (LSE:TIG).

A stabilising of demand has seen positioning bolstered across cyclical sectors, while defensive names have been added, as well as a new position in food retailer Tesco (LSE:TSCO).

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The trust’s largest overweight remains industrials, which comprises over a fifth of the portfolio (nearly 9% overweight versus the index). Financials remain the largest absolute allocation at nearly 27% (2% overweight versus the index).

As is typical for this investment trust, opportunities are often found across mid and small cap - a key area of specialism for Wright and a notable differentiator, as well as its overseas allocation, which is currently at 13%.

Compared to its FTSE All-Share benchmark, FSV is heavily in favour of the FTSE 250 at nearly 39% of the portfolio (25% overweight) and very underweight the FTSE 100 at just over 36% (near 48% underweight).

Dividend

The proposed final dividend is 6.3p per share, making a total of 9.54p per share (subject to approval). This will be the 15th year of the trust increasing its dividend per share. The proposed dividend is comfortably backed by the revenue return throughout the year, which grew healthily over last year’s figure.

Gearing

Throughout the year, gearing rose from 6.5% to 7.9%. The trust utilises contracts for difference (CFDs), rather than loans from banks in order to leverage, meaning leverage can be applied on a stock-by-stock level, rather than locking in overarching borrowing arrangements. The increased gearing reflects an improved earnings environment for UK Plc, and seeks to capitalise on a perceived cheapness in valuations.

Discount

The discount, with a singular exception, remained in single digits each day of the year, starting at -8.9% and ending at -8.8%. Since period end, the discount hasn’t moved in from this level. The current discount of -8.5% is at a notable depth to the five-year average of -4.4%.

ii View

Over the past year, there’s been little to no change in the bleak trend of funds departing UK equities as investors turned resolutely to the much-lauded US market.

However, encouragingly, even without a reversal of the flow of money or a substantial re-rating of the market, UK equities were able to deliver strong absolute returns in the year to the end of August 2024, as the corporate landscape showed signs of resilience and improvement.

What is more, as UK markets rose, Wright and Winton’s contrarian approach to picking undervalued businesses excelled and Fidelity Special Values outperformed by more than 7% versus the index, with a return of over 24% (actually exceeding the return of the US’ S&P 500 in GBP terms).  

Investors can be encouraged that the team’s stockpicking added value from a range of businesses housed in various sectors, and the strong set of results marks a second consecutive financial year of outperformance. It also extends the trust’s continued recovery from the struggle of the first half of 2022 – the beginning of a year of turmoil for small/mid-cap, while the large-cap heavy FTSE All-Share trod water.

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While capital appreciation is the predominant goal for FSV, the yield of around 3% is not insubstantial and, as per the managers’ dictum, makes for a smoothing of returns over the long term. Reflective of a stable of companies posting robust earnings throughout the year, the growth of over 8% in the proposed dividend for the 2023-24 year was easily covered by revenue returns.

The UK economy and equity market is at a juncture. While the convincing Labour victory in July brought some much-desired political stability to the country, the Autumn Budget leaves us with uncertainty regarding corporate health going forwards as we wait to assess the fallout of higher costs of national insurance for employers. Determining which businesses will be of sufficient quality to avoid the squeeze on margins and weaker profitability that could come about from these policies will be no mean feat.

On the other hand, the M&A market is lively and supportive policy reforms could well appear in the chancellor’s Mansion House speech and throughout the new government’s tenure.

While there have been very credible reasons to shun the UK, Wright has continually proved able to generate great absolute returns from investing in the underestimated and undervalued constituents of the market through various economic cycles.

Since his tenure began in late 2012, the trust has generated an impressive annualised return of just under 12%, nearly 5% per annum above its FTSE All-Share benchmark.

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The persisting discount to NAV throughout the year for FSV is perplexing. The current level of -8.5% is not as drastic as some peers, but is a fair divergence from the five-year and 10-year averages of nearer -4%. FSV is a popular and sizable trust that not uncommonly trades near to or above NAV.

Coupled with the board’s aim to at least protect the discount from double figures, this could be viewed as an attractive point for new investors to buy into an already undervalued portfolio.

FSV provides a differentiated option for unearthing value across British businesses whether large or small, proving its worth in the near and long term and earning its place in interactive investor’s Super 60 list of investment ideas.