UK investment trust Fidelity Special Values reports 5.2% half year total return

Fidelity Special Values Plc (LON:FSV) has announced its half-yearly results for the six months ended 28 February 2025 (unaudited)

Financial Highlights:

• The Board of Fidelity Special Values PLC declares an interim dividend of 3.36 pence per share, an increase of 3.7% from the prior year interim dividend.
• During the six months ended 28 February 2025, the Company reported a Net Asset Value (NAV) of +1.8%.
• Over the same period, the ordinary share price total return of the Company was +5.2% and the Benchmark, the FTSE All-Share Index, also returned +5.2%.
• The Portfolio Manager, Alex Wright, believes the UK market is well-positioned to withstand recent volatility due to minimal direct tariff exposure and defensively skewed sector composition.

Portfolio Manager’s Half-Yearly Review

Performance
Over the six months ended 28 February 2025, the Company recorded a net asset value (“NAV”) per ordinary share return of +1.8% and a share price return of +5.2%, compared to a +5.2% return for the FTSE All-Share Index (“the Benchmark”), all on a total return basis. This report seeks to summarise the period, highlight the key drivers of performance and set out the Portfolio Manager’s forward-looking views.

The Company’s NAV underperformance against the Benchmark was primarily due to the significant performance divergence between large and mid-cap stocks in the UK market. This was reflected in the FTSE 100’s 6.5% gain, compared to the FTSE 250’s 2.5% decline. Given the Company’s substantial exposure to mid-cap stocks, this market bifurcation weighed on relative returns.

Stock market and portfolio review
UK equities advanced, driven primarily by gains since the start of the calendar year. Global markets grappled with significant news flow as political developments, economic uncertainty and the outlook for interest rate cuts tempered investor sentiment.

The period began with UK equities posting losses in September and October amid moderating economic activity and uncertainty surrounding the implications of the UK Autumn Budget. Although a relief rally occurred in November, following President Trump’s election in the US and China’s new stimulus measures, UK equities remained broadly flat in the final quarter of the year. Global central banks continued to ease their restrictive policy stance, with the US Federal Reserve (“Fed”) cutting interest rates again in November. The Bank of England (“BoE”) followed suit, reducing its base rate to 4.75%. While the BoE downplayed the immediate impact of the new UK Government’s expansionary fiscal policies, it cautioned that measures from the Budget could drive higher inflation, potentially prolonging a higher interest rate environment. Investor optimism moderated in December after the Fed signalled fewer rate cuts for 2025. The BoE Governor Andrew Bailey also maintained a cautious stance on future interest rate decisions, refraining from providing specific guidance on the timing or extent of cuts in 2025. Meanwhile, domestic economic data continued to highlight challenges, with manufacturing and consumer confidence indicators remaining subdued.

2025 started on a positive note with UK equities delivering strong returns despite an initial bout of volatility in early January. Equities continued to advance in February, demonstrating resilience despite several geopolitical and trade policy developments emanating from the US. Performance across international markets diverged, as investors sought diversification opportunities away from US equities following their relative weakness. Meanwhile, growing investor confidence in the prospect of a ceasefire in Ukraine provided particular support to European equity markets. Investors also welcomed a further interest rate cut, the third since August 2024, bringing the BoE’s base rate to 4.50%.

From a sector perspective, market gains were primarily led by financials, with industrials and technology also delivering notable returns. Conversely, real estate and health care were the weakest performing sectors. While both value and growth segments advanced, value outperformed by a considerable margin. Large-cap stocks were the strongest performers, whereas small and mid-cap stocks underperformed over the period.

Engineering consultancy group John Wood was among the key detractors, as the market reacted negatively to its recent quarterly results. The company announced an independent audit review of its accounts and weaker free cash flow forecast for the next financial year, citing multiple headwinds. Encouragingly, its operational results were robust, and it remains in the early stages of its turnaround, continuing to benefit from an attractive franchise in oil services, energy and consulting. Additionally, at the time of writing, the company has re-engaged with its previous bidder, who had walked away in February 2024.

Geotechnical engineering company Keller underperformed, following a strong run over the past few years. Investors took profits as concerns grew that its US earnings may have peaked after two consecutive years of strong growth. Nevertheless, the company has benefited positively from large US projects despite mixed market conditions. The group’s geographically diverse portfolio and attractive valuation relative to peers should provide support as it navigates a potential slowdown in the US.

The position in IG Design, a manufacturer of celebrations products and gifts, also weighed on performance, as challenging retail conditions in the US and the bankruptcy of a large customer negatively impacted sales. Despite this near-term cyclical weakness, the company is trading at a highly attractive valuation and is supported by a robust balance sheet. The company’s management is actively working to improve the business’s margin profile.

Within the banking sector, several of our holdings, including Standard Chartered, NatWest and AIB Group, benefited from strong results, share buyback announcements and rising interest rate expectations. In February 2025, Standard Chartered announced a new $1.5 billion share buyback program after reporting an 18% increase in annual pre-tax profit. This growth was driven by strong performance in its wealth business and global markets division, pushing shares to a near-decade high. The diversified bank, which has an emerging market focus, is continuing to make strides in its turnaround journey. NatWest’s annual results also exceeded consensus estimates, supported by substantial share buybacks, lower impairments and rebounding margins, which contributed to share price gains in 2024. Conversely, not owning HSBC detracted from relative performance.

The position in tobacco group Imperial Brands supported performance. The company’s annual results highlighted further progress in stabilising its core tobacco business across key markets. It continues to provide an attractive distribution to shareholders. Meanwhile, the underweight position in health care group AstraZeneca was a key contributor to performance, as its shares declined following allegations of corruption in its China business.

Merger and acquisition (“M&A”) activity continued to be a driver for performance. Notably, the holding in Direct Line Insurance added value after Aviva agreed to acquire the company for £3.7 billion, a deal that would create the UK’s largest motor insurer.

We have been finding new investment opportunities in cyclical areas such as industrials, advertising and staffing, while also selectively adding back exposure to selected real estate stocks and housing related names, where demand appears to be stabilising and valuations remain attractive. We recently increased exposure to retailers specialising in big-ticket items such as kitchens and sofas, where sales are 10-25% below historical volumes. We anticipate an improving outlook as housing market volumes strengthen and interest rates decline, coinciding with a reduction in industry competition. We have also found opportunities in defensive sectors, adding to positions in Reckitt Benckiser, British American Tobacco and National Grid following recent weakness. Within the resources sector, we continue to maintain an underweight position in large-cap mining companies, reflecting our cautious view on iron ore. We also do not hold the two large-cap UK oil companies, Shell and BP.

Smaller-cap equities are a particularly attractive hunting ground today, as they trade at an aggregate price to earnings ratio of below 10x. The Company’s portfolio maintains a strategic bias toward small and mid-cap companies, comprising approximately 50% of the portfolio. We remain well diversified, with 105 holdings as at the end of February.

Use of gearing
We have continued to use contracts for difference to gear the portfolio’s long exposure and eliminate some of the currency exposure for those holdings listed outside of the UK. Overall, the Company’s net gearing increased from 7.9% at the beginning of the period to 10.9% at the end of February 2025. Gross gearing increased from 8.3% at the start of the period to 10.9% at the end of the period.

Outlook
Despite their improved performance over recent years, UK equities remain relatively cheap compared to other markets. Historically, the UK market traded at around 85-90% of global markets, but this has dropped to around 75% in recent years1. While other markets face excessive valuations and the risk of a de-rating, the UK market benefits from a meaningful margin of safety, offering protection if exogenous events impact markets. The market’s consensus last year was that US dominance would persist; however, trends have moved in the opposite direction so far this year.

While we are undoubtedly entering a turbulent period in global politics and economic uncertainty, as tariffs will likely impede global economic growth, the UK market is well-positioned to withstand this US-centric storm. Direct tariff exposure is minimal given the UK’s small export base and service-oriented economy. Moreover, the UK’s sector composition is skewed toward defensive areas such as consumer staples and utilities, which could provide resilience against global growth weakness and trade downturns. This is strikingly different to other regions with high export dependencies to the US and significant sector weightings in affected areas, such as technology, aerospace and manufacturing which are heavily reliant on dispersed globalised supply chains.

The UK market’s international nature means that it will feel some effects from the tariffs, but mostly from the broader implications of a likely deceleration in US and global economic growth, rather than direct tariff-related hits. Recession risks have clearly escalated, and the lingering uncertainty is what the market is currently pricing in. The Company’s diversified portfolio and its underweight positions to the most exposed areas, such as oil and pharmaceuticals, should prove relatively supportive, but its cyclical holdings will feel the effects of this. We have been strategically adding to attractively valued domestic-facing businesses that are relatively insulated from these events, supporting a meaningful overweight to UK revenues compared to the Benchmark. We believe there are numerous attractive opportunities prevailing in the current market, available at low valuations, and we continue to uncover compelling investment ideas, particularly in periods of high market volatility.

The unpopularity of the UK market has made it an attractive hunting ground for contrarian value investors. We believe that the combination of favourable valuations and the large divergence in performance between different markets provides a strong opportunity for attractive returns on a three-to-five-year view. Their unloved status means we are finding overlooked companies with good upside potential across industries and the market cap spectrum.

While domestic investors have yet to fully recognise this value, it is being acknowledged by other market participants. Overseas corporates and private equity firms are actively capitalising on these attractive valuations, as evidenced by the strong historical M&A activity in the UK market. We have experienced considerable success with M&A activity across the portfolio in the last year. The low valuations are also reflected in the substantial buyback activity among UK corporates.

We believe current market conditions continue to favour our value-contrarian investment style. The vulnerability of growth companies is that they tend to be priced for optimism, with share prices declining significantly if good news does not materialise. The opposite is true for value companies: If the consensus view is negative, an investor does not lose much if it turns out to be correct; in contrast, if it is wrong, the share price can move significantly higher.

Overall, we believe the UK market has an underappreciated richness of opportunity, combining strong earnings growth, high dividend yields and low valuations. The portfolio benefits from a favourable upside/downside profile and our holdings trade at a meaningful discount to the broader UK market, despite exhibiting resilient earnings, superior returns on capital and relatively low levels of debt. This quality profile reinforces our confidence in delivering attractive long-term returns for investors.

1 JP Morgan Equity Strategy, DataStream, February 2025. Valuations adjusted for sectoral differences between markets and is based on 12m forward P/E of the MSCI UK Index vs MSCI World Index (both are sector neutral indices).

ALEX WRIGHT
Portfolio Manager
25 April 2025

Twenty Largest Investments
as at 28 February 2025

The Asset Exposures shown below measure exposure to market price movements as a result of owning shares, corporate bonds and derivative instruments. The Fair Value is the realisable value of the portfolio as reported in the Balance Sheet. Where the Company holds shares and corporate bonds, the Asset Exposure and Fair Value will be the same. For derivative instruments, Asset Exposure is the market value of the underlying asset to which the Company is exposed, while the Fair Value reflects the profit or loss on the contract since it was opened, and is based on how much the share price of the underlying asset has moved.

1 Asset Exposure is expressed as a percentage of Shareholders’ Funds.

Fair Value and Asset Exposure of Investments
as at 28 February 2025

The Company uses gearing through the use of CFD positions. Gross gearing as at 28 February 2025 was 10.9% (31 August 2024: 8.3% and 29 February 2024: 5.9%).

1 Asset Exposure is expressed as a percentage of Shareholders’ Funds.

2 The Asset Exposure column for cash at bank has been adjusted to assume the Company traded direct holdings rather than exposure being gained through long CFD positions. The amount is derived by taking the cost of the shares underlying the long CFDs when the contracts were opened less the cash at bank balance at the period end.

Fidelity Special Values PLC (LON:FSV) aims to seek out underappreciated companies primarily listed in the UK and is an actively managed contrarian Investment Trust that thrives on volatility and uncertainty.