Value investor names the bargain banks he’s backing

Alex Wright, fund manager of Fidelity Special Values (LSE:FSV), scours the market to find cheap shares that have good recovery potential. A sector he's finding particularly attractive at the moment is banks. However, while there’s exposure to UK domestic banks, his top holding is an Irish bank, while he's also backing banks based in Georgia and Kazakhstan that have UK listings.

Wright tells ii’s Collectives Editor Kyle Caldwell why the investment trust has around 60% in UK mid-cap and small-cap stocks, and names a sector he doesn't have much exposure to, and a recent purchase that's got off to a strong start.

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Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Alex Wright, manager of the Fidelity Special Values investment trust. Alex, thanks for coming in today.

Alex Wright, manager of Fidelity Special Values investment trust: Thanks for having me.

Kyle Caldwell: So, Alex, you're a value investor. You like to buy companies trading on cheap valuations that have good recovery potential. Could you talk us through your approach?

Alex Wright: That's right. So, Fidelity Special Values and Fidelity Special Situations, the open-ended fund, they both invest in a value contrarian way, which for me means buying something that is worth more than the market is currently paying for it. And generally, that means stocks that have got some kind of issue which is making people not pay up for fair value.

And then we want to look at how is this value likely to be realised over time. So, that may be in a recovery in the company itself, or maybe a change in the industry where that company is operating. And that's how we build up the portfolio.

Kyle Caldwell: In terms of company size, you invest across the UK stock market, but with the investment trust, there is a preference for the mid- and small-cap parts of the market. Could you explain why?

Alex Wright: Yes, you're right. About 60% of Fidelity Special Values is invested in mid- and small-cap companies. So, companies below about £2 billion per market cap. And the reason we do that is the UK is a quite wide investable universe of about 1,000 companies. But at the top end of the market, it's quite concentrated. So, quite a lot of that market cap is in really quite a small number of companies, so there isn't that much choice.

If you go down the market-cap spectrum, you get many more companies to choose from. It gives you a much bigger investable universe, rather than focusing on the 10 or 20 biggest companies, which make up a large part of the market in terms of investable assets. So, particularly when we look at price-to-earnings (P/E) ratios, which is a key valuation metric, you're paying about 7.5 times for the portfolio today, and that's similar between mid, small, and large-caps. So, I think value across the market-cap spectrum in the UK market today.

Kyle Caldwell: Could you pick out a couple of companies trading on low valuations that you think are unjustly cheap? And are there any particular sectors that stand out as well?

Alex Wright: We're quite diversified across sectors and we've got about 100 holdings altogether. And so we very much want the bottom-up stock picking to be the power of performance. That said, there are some areas that are bigger in the portfolio. Banks is one where we've got quite a lot of holdings and indeed the biggest stock in the fund is a bank, Allied Irish Bank AIB Group (LSE:AIBG), and it's quite topical because I was out there just two weeks ago meeting not just the AIB but also the competitors, some of the house builders and some government agencies.

I think this is where the differentiation of the trust in our process really comes in, because while some of the UK banks have been struggling a bit this year, things are very different in Ireland, whereas AIB is still priced like a UK bank. So, it was on about six times earnings, so cheaper than the market as a whole. But, actually, if you look at what's happened to their earnings over the last year, they've roughly doubled. So, an incredible performance and that's very much because of the exit of some of the competitors in Ireland.

So, Ireland was already a reasonably limited banking market in terms of competition, only five key banks, and that's gone down to three in the last year. And that's really good for the returns of those that are left, and AIB has really been able to benefit from that in terms of growth in deposit accounts and also growth in margins because of the change in the interest rate environment.

I think there's a lot more to go in Ireland because of the strong economic and strong political situation that you've got there. In terms of the very disadvantageous regulations that have been on the banks for a number of years post the global financial crisis, [they] are starting to loosen at the margin.

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Kyle Caldwell: And which UK banks do you own?

Alex Wright: Again, we're quite diversified within the UK and so we do have holdings in some of the big UK domestic banks, so NatWest Group (LSE:NWG) and Barclays (LSE:BARC), but also a holding in Standard Chartered (LSE:STAN), which is the biggest of the UK bank positions, but also some smaller banks. So, Bank TPC, which is UK listed but operates only in Georgia.

Kaspi, which is a Kazakhstani bank, which also has a London list, and then Secure Trust Bank (LSE:STB) and Close Brothers Group (LSE:CBG) as well, which are smaller UK banks.

So, I think the sector as a whole is interesting. There are clearly risks in banks and so being diversified, and playing different business models, different geographies, is something we've chosen to do over the last year, and has been really good for performance. Indeed, AIB has been the biggest contributor to performance and banks as a whole are actually up over 30% over the last 12 months.

Kyle Caldwell: You've mentioned a couple of overseas stocks that you hold, and the trust can hold up to 20% in overseas companies. Are there any other sectors as well as banks where you have a lot of overseas exposure, too?

Alex Wright: So, we tend to use that overseas exposure for sectors where there are UK analogies. So, we [have] particularly done that historically in banks. So, with AIB, also in healthcare, where we own a big position in Roche (SIX:ROG). So, the geographic exposure of Roche is very similar to a GSK or an AstraZeneca, which are quoted in the UK, it's a global healthcare company, but we think the valuation and the balance sheet is more attractive there. And the team at Fidelity, the analyst team that we very much rely on to help us with ideas, they cover stocks on a pan-euro basis. Again, sometimes a European quoted name will be better than the UK equivalent.

Kyle Caldwell: You mentioned that you are diversified across sectors. Are there any sectors you are particularly light in compared to the index?

Alex Wright: The key underweight that we've got today, and indeed we've generally had since we started running the trust all the way back in 2012, is in the resources sector. We do have some small-cap mining exposure, but we don't own any of the big miners, the Anglos, the Rios, the Glencores. That's generally been because metals prices have been quite buoyant for the last decade. They've generally been above replacement cost and therefore the return on equity (ROEs) of those businesses have been quite high and the price to books have been quite high. So, while the resources sector might look quite cheap on a P/E, that's because we think that the metals are overvalued, particularly in iron ore and thermal coal, which would be the key metals for those big caps. And so we're very underweight that sector, having only some smaller-cap exposure in mineral sands and copper.

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Kyle Caldwell: And given that you're seeing plenty of valuation opportunities in the UK market, have you been busier this year in terms of portfolio activity? And could you name a recent example of a company that you've bought?

Alex Wright: I wouldn't say turnover is higher than normal. Generally, when you see big movements in markets, that's when there is big turnover where we've increased the gearing. Today, the gearing’s at a more normal level, about 6% or 7%. The last time we made a lot of changes would have been in the summer of 2020 after the big Covid drawdown. And we've done that before, back in 2012, when there was the European banking crisis as well. So those very large events tend to generate big turnover. Today we're on average, so about a 30% turnover.

One of the more mid/small-cap stocks that we've been buying into recently, and there's been some news flow on, is Ascential (LSE:ASCL). I think this is typical of the UK market malaise. About 12 months ago, Ascential said that they were going to split up their business, which is a conglomerate, three different businesses, and they were looking to sell one of the businesses and list one of the others and go back to [being] a core events business.

The stock initially did really well on that announcement, and went up about 20%. But a large amount of their shareholder base were funds that were seeing redemptions. So, interestingly, over the last 12 months, the stock’s got all the way back to where it was before the announcement of this split up, despite the fact that they continue to look at this plan.

So to us, that looked really interesting. There was a plan in train and it made a lot of strategic sense. You clearly looked at the valuation comps in other markets. They were much higher and there probably were willing buyers of those assets. So, that's something we started buying in the summer. And [it] has worked very quickly, where they announced just a couple of weeks ago that they were selling two of their assets and the stock performed very strongly. I think that is what you see a lot of stocks doing in the UK market. The fact that overseas competitors or US quality companies or private equity companies are seeing the value and are looking to buy out UK companies on the cheap. We've had quite a lot of success with M&A across the portfolio in the last 12 months.

Kyle Caldwell: Finally, do you have skin in the game?

Alex Wright: I invest both in the investment trust, which will be my larger holding, and also the open-ended fund Fidelity Special Situations which we run.

Kyle Caldwell: Great to hear and thank you very much for your time, Alex.

Alex Wright: Thank you.

Kyle Caldwell: That's it for this episode of our Insider Interview. Please like, comment, and do hit the subscribe button and hopefully I'll see you again.