Alex Wright, portfolio manager of Fidelity Special Values PLC, holds a more optimistic view for 2021 for UK equities due to recently announced vaccine breakthroughs and the end of Brexit negotiations. Against this backdrop, he reviews an increasingly attractive opportunity set for value investors wherein a broad range of lower growth businesses remain very cheaply priced.

Key points

  • There is an unusually broad choice of attractively valued stocks with good upside potential.
  • We are not having to compromise on quality, nor buy companies severely impacted by the pandemic.
  • The conclusion of Brexit negotiations and the roll-out of vaccines should lift some of the uncertainty that has plagued UK equities.

What is your investment outlook for UK equities in 2021? 

Looking ahead to 2021, I am optimistic. Recently announced vaccine breakthroughs are encouraging, as the broad availability of efficacious vaccines is necessary to allow a resumption of normal economic and business activity. However, not until we see mass roll out of the vaccines is this likely to make a noticeable difference. From a macro and geopolitical perspective, many uncertainties remain from the outcome of Brexit negotiations to the timing of the withdrawal of support measures and likely future tax increases. While a no-deal Brexit scenario would clearly be a negative outcome, the robustness of UK supply chains through the Covid-19 crisis does give us some comfort that companies are better prepared than previously thought. Deal or no deal, the end of negotiations should lift some of the uncertainty that has plagued UK equities for the past five years. In terms of investment opportunities, I am very excited as I currently find a lot of very attractively valued companies and I am not having to compromise on quality nor having to invest in businesses severely impacted by the pandemic.

What do you think could surprise the market in 2021?

2020 has presented us with its fair share of surprises, no doubt 2021 will have new ones in store for us. A Brexit deal and a rapid mass rollout of the vaccine would be very positive outcomes. However, we could well be surprised to see no Brexit transition deal and a successful vaccine roll-out actually meaning UK equities rise in value whilst US stocks fall, given the huge valuation disparity between these markets. Indeed, so far, government reactions to the pandemic have resulted in a very unusual recession. Some businesses have not been able to operate for lengthy periods due to lockdowns, a very unusual situation. Meanwhile, authorities have been decisive in introducing extensive support measures such as the furlough scheme, which have helped cushion some of the impact. Households haven’t been able to spend as much they would normally do and savings rates have picked up. This has resulted in a very unusual backdrop whereby some retailers, despite the lockdown, are meaningfully exceeding pre-Covid estimates in areas such as electronics, bike sales, sports equipment and DIY. We have also seen a significant pick up in housing sales. Inevitably, some businesses and industries will emerge from the crisis considerably weakened by the consecutive lockdowns. 

From a market perspective, after the seemingly irrational moves seen in the spring, investors seem to have updated their playbook so as to reflect more accurately the impact of the pandemic on individual businesses so I am hoping for more rational share price moves going forward, although at this stage the market remains very one-sided, with some growth stocks on stretched valuations, while a broad range of lower growth businesses remain very attractively valued.

What themes, sectors or regions would offer opportunities or potential risks in a post Covid-19 world? 

Both UK equities and value stocks have been out of favour for a prolonged period and their share prices have proved particularly susceptible to the pandemic. While it has proved a challenging backdrop for value investors, this has resulted in an unusually broad choice of attractively valued stocks with good upside potential, including companies whose earnings are already exceeding expectations. Improved visibility in respect of the timing of mass vaccine rollouts and in the wake of the conclusion of Brexit negotiations should boost investors’ confidence and lead them to broaden their investment horizons beyond the narrow range of secular growth stocks that have been in favour. While this may well lead them to reassess their expectations in respect of those stocks, UK value stocks remain cheap and offer amazing upside potential. We have recently seen a pick-up in mergers & acquisitions (M&A) activity, a sign that foreign corporates and private equity investors are recognising the value on offer. While the mass rollout of vaccines will be positive for those businesses most impacted by the pandemic such as travel, leisure and hospitality, many will emerge from the crisis considerably weaker and are likely to need time to fully recover.

Glossary:

M&A: Mergers & Acquisitions - a general term referencing the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another.

How do you expect sustainability factors to influence returns and how is this reflected in your portfolios?

There is no doubt that sustainability factors are playing an increasing role in influencing stocks’ returns and valuations. Corporate governance has always been a key consideration for Fidelity. It is particularly important for me as a contrarian investor whose focus is on unloved stocks and limiting downside. When I consider investing in a stock, I pay a lot of attention to any potential risk that could affect the share price, and Environmental, Social and Governance (ESG) factors are key considerations. At Fidelity, our research analysts consider ESG as part of their in-depth fundamental analysis and highlight any potential issue. However, rather than simply looking at a company’s track record and avoiding poor ESG performers altogether, we engage with company management and discuss our concerns and their plans going forward. This not only encourages improved practices but can also be a source of value creation as any improvements can then translate into share price re-ratings. For instance, we bought UK listed global utility firm ContourGlobal when it was shunned by ESG-conscious investors, but through engagement with the company we could see a marked shift in the outlook of management. The company recently announced that it had scrapped plans to build a coal-fired power plant in Kosovo and said it would make no further coal plant investments globally. The stock has been one of the portfolio’s strongest performers this year.

Within your portfolio, what areas have highest convictions and what areas are you avoiding? 

We have significantly increased our exposure to specialist retailers such as Halfords and Dixons, car distributors, DIY stocks as well as housebuilders. These are all areas that are seeing increased demand as households reassess their priorities in light of the pandemic and have more disposal income, and where we believe the changing dynamics caused by the virus are likely to be longer lasting than currently factored in. We continue to favour life insurers, which are well regulated companies with good risk management and are seeing strong demand for bulk annuities and pension de-risking. The sector offers an attractive combination of cheap valuations, strong demand/supply fundamentals and growing earnings. Conversely, we are underweight mainstream banks. While cheap, they lack a medium-term catalyst to re-rate given the low-rate environment. Instead, we have bought into UK listed emerging market players Bank of Georgia, TBC bank and Kaspi, which are able to generate strong returns in the current interest rate environment but have been overlooked or lumped in with the mainstream banks. We are also underweight in energy and no longer have exposure to UK oil majors Shell and BP, which have cut their dividends and are embarking on a complex and high-risk transition towards a more diverse energy mix.

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