Why I no longer invest in US shares

In our latest Insider Interview, Fidelity UK value investor Alex Wright explains why he's been cutting down on overseas exposure at Fidelity Special Values Ord (LSE:FSV).

The investment trust can hold up to 20% in overseas stocks, an allowance that Wright has previously taken full advantage of, but this weighting has now fallen to 11% due to US stocks gradually departing the portfolio.

Wright explains why he no longer invests in US shares, where he's finding value opportunities in the UK market, and his approach to investing in ‘unloved’ stocks.

Fidelity Special Values is one of ii’s Super 60 investment ideas.

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

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

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

Kyle Caldwell: So, Alex, you invest across the UK market, but you do have a longstanding overweight position to UK mid-cap and UK small-cap stocks versus the FTSE All-Share index. Could you explain why the fund is structured in this way?

Alex Wright: Yeah, so you're right. The fund can invest in anything quoted in the UK and, actually, up to 20% overseas, and we're using about 11% of that today. So, a bit below history. The reason we invest more in mid- and small-caps, which is about 60% of the fund, is there's just more choice there in the market. The UK market is quite concentrated when you go up to the top 10, top 20, companies. So, there might not be many companies to choose from.

Whereas if you actually look at the investable universe, there's probably about 1,000 companies to choose from. The added advantage, as well, is that as you go down the market-cap spectrum and start looking at those 1,000 companies, there's many fewer other people looking at them. So, the chance of finding something uncovered, misunderstood, is that much more as you get down the cap spectrum, as well.

Kyle Caldwell: You mentioned you have around 11% in overseas companies, which is lower than usual. What is the typical exposure and why have you been reducing overseas companies?

Alex Wright: So we've been as high as 20% and we've regularly been above 16% or 17%, and that tends to be in both European and US companies, which are covered out of London by the Fidelity analyst team, which is really key to the process compared to Asian companies, which tend to be covered out of Asia.

It's primarily that we don't own any US companies anymore. So, they would have been 6% or 7%. Actually, at one time, maybe up to 10% if we go all the way back to maybe 2012 when we took on the investment trust.

But today, I've just found it very difficult to find any value in any of the US companies, even in unloved sectors like banks and old tech, which were some areas that we did used to invest in in the US.

So today, we're primarily just in European companies and most of that is actually in Ireland, which I count as largely, another sort of home market. It's obviously right next to the UK. The economy's very dependent on trade with the UK, so it's more like an extension of the home market rather than being truly abroad like the US or mainland Europe would be.

• Ian Cowie: will warmer relations boost investment trust laggard?
• Is this area of UK market one investors should focus on?

Kyle Caldwell: And when did you reduce that US exposure? Was it a more recent move, or has it been gradual over the past couple of years?

Alex Wright: Itwas more of a gradual thing. So, it's when companies worked, we sold out of them. So, some of the big US positions were like Electronic Arts Inc (NASDAQ:EA) back in 2012, and that did very well. We maybe sold that in 2015, 2016. Citigroup Inc (NYSE:C) was at one point actually the biggest position in the fund, [at] 6% of the fund. We sold that in 2020. So, it has been a gradual process where that percentage has been going down. More recently, Schlumberger Ltd (NYSE:SLB) was the last US position that we sold, maybe six or seven months ago.

Kyle Caldwell: Moving back to these shores, so within the UK mid-cap and small-cap part of the market, are there any particular sectors that stand out for you or any particular types of businesses?

Alex Wright: The type of investment we look for are undervalued companies that are misunderstood, [and they] can be present in any sector. But we have generally focused on some areas that I think have been consistently misunderstood. So, financials have been a big weight over time. And certainly until recently, particularly banks were really out of favour.

Actually, at the margin, maybe more people are waking up to banks being good businesses producing good earnings, so if anything, we've reduced that area, but we are still overweight, also including insurance, some real estate companies, [and] some other financials. But we really do invest across absolutely everything.

Kyle Caldwell: You are a UK value investor. Could you talk us through the key ingredients that you like to see in an unloved business that you then hope will recover over time?

Alex Wright: A company being cheap is clearly the first thing we look for. So, companies that are unloved and were an issue either on a sector level, so in the industry that the company operates in, or the company itself is clouding people's judgement about why this is actually a valuable company. So, often that is that short-term financial performance is poor, and we think it can turn around.

And it's that working out what will turn it around, what will be the catalyst, that's really key to the process. We don't just buy cheap companies in the hope that they turn around. We're not just a classic deep value screening fund. We do a lot of work meeting the companies, meeting the competitors of those companies, suppliers, talking to industry consultants, [and] using the broad analyst team at Fidelity to really work out what's changing, and why will this company be valued more highly in the future, so avoiding sort of value traps, effectively companies that are cheap, but stay cheap.

Kyle Caldwell: To illustrate the way in which you invest, could you provide an example of a company you bought when it was unloved and which went on to recover?

• Time to be bullish or bearish? Five pros give their take
• The 20 most-popular dividend shares among UK fund managers

Alex Wright: There's loads of companies that have worked in the fund. I suppose looking at something that we've been in until recently is Barclays (LSE:BARC) in the banking sector. Clearly an unloved sector, also their business model somewhat unloved in that they do investment banking and retail banking, but where we saw some quite strong franchises and an ability to get returns up, as well as a management team that was motivated to do that, and also a reduction in competition.

So, the exit of some investment banks like Credit Suisse, the exit of some of the challenger banks like Virgin disappearing in the UK. So, that's classic to what we like to see both in terms of change happening in a company, but also in the industry where the company operates. That stock has done very well, it's up about 100% just over the last 12 months. And so while I'd say the company isn't exactly expensive, it's much more appropriately valued than it was when we invested.

Kyle Caldwell: And what is your typical holding period for a company? Do you have a certain price target and then once that company hits that price target, do you then look to sell and put that money to work in a cheaper company?

Alex Wright: Yes, we very much do. So, we tend to think what can this company do on a three- to five-year view? I think the market is quite short-term focused, so often it's asking what's it going to do on the next six to 12 months, whereas we're thinking [about] what's going to happen over three to five years.

But often, if that three- to four-year view starts to play out, you don't often have to hold for the whole period because the market gets excited about the turnaround coming through. People tend to pay up for that ultimate five years a bit ahead of time. So, I'd say our average holding period is more like three years, and the turnover of the fund would be closest to 33%.

Kyle Caldwell: As well as aiming for long-term capital growth, Fidelity Special Values also pays a dividend. The current yield is around 2.8%. How do you structure the portfolio to deliver both capital growth and income growth?

Alex Wright: We're very much looking at total shareholder returns. So, what can a stock deliver in terms of total return over that three- to five-year time horizon? Sometimes quite a bit of that will come from the dividend yield. So, a great example of that would be Imperial Brands (LSE:IMB), which been a great contributor to performance. A lot of the five-year performance has come from the fact that that's had a 10%-plus dividend yield, but then we've seen capital growth on top.

Other times, companies won't pay a dividend at all, but I think there's very attractive capital growth. So, again, there can be changes in the dividend-paying ability of the fund.

What the board looks to do is keep my mandate unconstrained. So, where the absolute best opportunities are, that's where we invest, even if sometimes they're coming from dividends, sometimes they're coming from capital. Then, we always try and hold back as much income as possible, so that if dividends have gone down temporarily in the portfolio, a bit like they did in Covid in 2020, we have the ability to maintain a dividend, which is what we did then.

As you look at it today as well, the underlying portfolio yield for the companies we own is much more like 4%, but then we do take fees out of that income as well, which is why the dividend yield of the trust is lower than the underlying portfolios.

Kyle Caldwell: You don't have any exposure to the two large-cap oil companies, Shell (LSE:SHEL) and BP (LSE:BP.). These two companies, you typically see them in the top 10 holdings of a lot of UK equity funds, particularly those that are also aiming to pay a dividend. Why don't you own this duo?

• Fund managers’ favourite UK smaller companies
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

Alex Wright: We have owned a big position in Shell and we sold out of that at the back end of last year. There was a point in 2020 when Shell got to be the biggest position in the fund because we were very excited. It was about 6% of the fund at the time. Particularly in the three to four years running up to Covid, oil was a very out of favour area and there were a lot of people who were divesting for environmental, social and governance (ESG) reasons. There was also talk about peak oil and electrical vehicles growing very rapidly and therefore demand going down. So, it was a very out of favour area. And the large caps and the small caps were all attractively valued, and I thought of BP and Shell, Shell was much more attractive.

Since then, we've seen a much higher oil price, a much slower growth in the electrification of car fleets than there was maybe anticipated. And, actually, the lack of capex investment from the majors reducing some of the production growth that was maybe seen.

So oil's come much more back into vogue as an investable sector, but I think most people haven't had the confidence, because they probably haven't looked at oil for a long time because it was out of favour, to actually go down the market cap spectrum, and they've tended to stick with just those big majors, so I don't think the valuation of BP and Shell looks particularly good. Actually, through history, this is a commodity sector, so the returns available from these companies aren't actually that good.

So, you don't want to own the stocks when they're in favour because these aren't great companies over time. They're largely cost of capital, maybe unfortunately, particularly in BP's case, sub-cost of capital. So, they haven't produced economic returns. They haven't produced the 10% return on capital that we'd hope a company would produce. So, the longer you own that type of company, the worse the returns tend to be.

So, we've tended to focus our oil investment in smaller-cap companies, particularly Energean (LSE:ENOG), the biggest small-cap position. Or [we focus on] companies that are a bit more out of favour. So, we have a 2% position in TotalEnergies SE (EURONEXT:TTE). I think that's a business that, again, there's a bit more ESG investment still in Europe. So, again, investors there have been a bit more wary of investing, particularly because they do operate in Africa, which is obviously geopolitically trickier and then also because the French market has been out of favour, particularly around some of the political issues that were happening towards the end of last year. That gave us the chance to move the final part of the Shell position into Total.

Kyle Caldwell: Alex, thank you for your time today.

Alex Wright: Thank you for having me.

Kyle Caldwell: So, that's it for our latest Insider Interview. Hope you've enjoyed it. Let us know what you think. You can comment, like, and for more videos in the series, do hit that subscribe button. And hopefully, I'll see you again next time.