How to Avoid a Value Trap

VIDEO: Fidelity's Alex Wright is looking for unloved companies which he believes are set for a turnaround - but avoiding those that are cheap for good reason is key

Holly Black 3 February, 2020 | 11:18AM
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Holly Black: Welcome to the Morningstar Series "Why Should I Invest With You?" I'm Holly Black, with me is Alex Wright, he's manager of the Fidelity Special Situations Fund. Hello.

Alex Wright: Hi.

Black: So, I know you've been here before, but you want to tell us just quickly what the fund does?

Wright: Yeah, so special situations is a value contrarian fund. So, we're looking for stocks that other people have brushed aside because there's something currently perceived wrong with a company and that leaves them at cheap valuation. And what we're looking to do is, do the work, really dig into the fundamentals of companies and see where we think actually that prevailing market view or consensus view is wrong. And therefore actually, the company's prospects are better than people are currently thinking.

Black: So, value and contrarian are quite scary words for a lot of investors at the moment, do you think that this style has been out of favor. What's your view on that?

Wright: Yeah. So, over the very long term, and we're talking sort of the the sort of 50-year, 100-year academic surveys, value stocks have shown to outperform generally, compared to growth stocks. So, buying the cheapest, the more unfashionable companies, has generally been a winning strategy. That's very much not been the case over the last 10 years. So that's quite a long period post the financial crisis. And that's been because of the persistence of ultra-low interest rates. And, worries therefore, about economic growth has generally led people into what are now very fashionable growth stocks. And I think that has been a key headwind to performance. I think, though, what's important within styles, whether you are growth or value, do you have a good stock picking engine behind you as well. So, while I may look at the universe, that's value, clearly, some of those stocks are value traps. Some of them are value opportunities, and it's been able to pick those opportunities by doing the deep fundamental research that's allowed us to still outperform during this period when it's been actually a really tough market for value investors.

Black: So, what are some signs in a value trap? And that is a stock that's cheap, but for a good reason.

Wright: Yeah. So, I think particularly, there's been increased disruption over the last 20 years, and particularly over the last 10 years from the internet. So that is clearly a game changing technology that has disrupted many businesses globally. So, while I'm looking for companies that are struggling today, I want ones that can turn that around, not businesses, which are structurally challenged and therefore might go away. So clearly, these things like newspapers, they were a great business 20 years ago, today, they're not a great business that has been structurally challenged. You could say the same about many areas of retail as well. Internet shopping is new, it's here to stay, it's not going to go away. So again, unless you adapt, it's very tough. So that's where our real work goes. Is this a cyclical challenge or a challenge that can be overcome or is it actually structural challenge that isn’t going to go away?

Black: And what are some of the things that get you excited where you think you found a value opportunity?

Wright: So, it's very varied. And I think it's important to be varied so that you're not playing a sort of macroeconomic theme or one big thing in the portfolio because I think our value add at Fidelity and particularly in this process is individual company analysis, seeing what's happening in that company, in that industry. So, we're right across the market cap spectrum, everything from £100 billion to £100 million companies we're in many different sectors. So be they defensive sectors, like health care, or staples, utilities, or more cyclical sectors, like financials or retailers. So, I think you can find these type of companies in many different places. And we do have a diversified 80 stock portfolio reflecting that.

Black: And are there any sectors that are particularly good to find these opportunities in at the moment?

Wright: So, I think right now, it's an interesting market in the UK because generally investors have been shying away from the UK because of political uncertainty, firstly around Brexit and then also around the general election that we've recently had. Clearly, now there is more certainty. So we have a large majority government now, you don't have the indecision that you had before, but you still do have the Brexit process, which is still an unknown, and that is leading particularly domestically focused stocks to be cheaper than their international earners. So, the UK is a very international market 70% of the earnings of the the FTSE All Share are ex-UK, so nothing to do with the UK economy. The company is just listed here. And 30% is to the UK itself. And we are overweight, we're actually about 40% to the UK itself today because I think that's where the biggest opportunity lies. And if you were to look in terms of particular sector exposure, the biggest sector we've got exposure to is the life insurance sector. So, for me, that's the most interesting value opportunity today.

Black: Okay. Well, thank you so much for your time.

Wright: Thank you.

Black: And thanks for joining us.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Holly Black  is Senior Editor,