Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

According to Aruna Karunathilake, manager of the Fidelity UK Select Fund, there has been a “long shadow” cast over the UK market for approximately five years now. Brexit, an antithesis to the certainty investors like to see in markets, combined with the pandemic to turn ours into something of a ‘pariah’ market.

But things may, finally, be looking up. Brexit is behind us, and a faster-than-expected vaccine rollout could see our economy reopen for business sooner than our neighbours.

In the manager’s eyes, things look good. He says: “I think we could have a COVID bounce in the short term and a Brexit bounce in the long term which makes me pretty positive on the outlook for the UK both in 2021 and beyond.”

Karunathilake seeks to own good businesses for the long term - as such, he thinks his fund will be in prime position to reap the rewards once the UK has returned to favour.

Tom Stevenson, investment director here at Fidelity, shares Karunathilake’s optimism. That, combined with the manager’s quality-focused investment approach, is why he’s chosen this as one of his five ISA fund picks for 2021.

Tom recently caught up with the manager to discuss his approach and his outlook for UK equities.

Looking up

Times have been tough for the UK, but Karunathilake knew that fortunes would eventually change. When we spoke to the manager just over six months ago, he recognised the UK’s turnaround potential. He told us that “patient investors should consider building a position while evaluations in the UK remain favourable”.

That’s exactly what he’s been doing. He explains how the UK’s pariah status has presented opportunities: “When I look at valuations, the UK market seems very attractive compared to other markets. Companies like Unilever are trading at a discount to US peers - Colgate in this case. Even Domino’s Pizza, which does exactly the same thing in the UK as it does in America and Australia, trades at a significant discount to the Domino’s Pizzas listed elsewhere.”

This UK ‘discount’ is ideal for a manager like Karunathilake. His mantra is quality first, operating with a bottom-up focus that looks at individual companies and their fundamentals before the macro backdrop.

To ensure that he’s seeking out the best quality options across the UK market, the manager uses his “checklist” to critique prospective investments.

He likes companies with a strong brand, or “moat”, which keeps the competition at arm’s length. He cites Burberry, whose strong brand means it can charge that bit more, and Rightmove and Auto Trader, both of which dominate their respective industries, as examples. He also wants to see companies that demonstrate good cash generation, a strong balance sheet and a simple business model.

That leaves with Karunathilake with a relatively concentrated portfolio of around 40 stocks. It’s a figure he feels offers enough diversification while capturing the value of each. As he explains: “I would rather invest in a smaller number of really high conviction positions rather than diversify out into lower conviction names.”

The manager feels these principles have helped him find opportunities through a difficult 2020. He explains that he is “is especially positive on companies exposed to these areas which will emerge stronger from this period as a result of competitors either having gone bankrupt or just being forced to curb their activity because their cash is strapped”.

He points to Next as a case in point: while many of its competitors like Debenhams and Topshop have been forced off the high street, Next should benefit when shoppers do eventually return to stores.

It’s an approach that draws him to certain areas of the market over others. He’s optimistic right now about consumer facing sectors like leisure and retail, which should benefit most from a release of pent-up demand. He also feels good about housing and construction, areas he feels will benefit from government investment over the coming years.

Though he’d rather ignore labels like ‘growth’ and ‘value’, his focus on quality companies lends itself more to the former. That means that his fund tends to lag during sharp rebounds, when lower quality companies tend to come to the fore. But that doesn’t worry the manager. As he explains: “Experience shows that when the recovery broadens these attributes come back into focus and high-quality companies tend to outperform over the long run.”

Find out more about Fidelity UK Select here.

Important Information

Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. The Fidelity UK Select Fund may invest in overseas markets, so the value of investments could be affected by changes in currency exchange rates. The fund invests in a relatively small number of companies, so may carry more risk than funds that are more diversified. The fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The fund may also use currency hedging. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

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