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.

When Tom Stevenson, investment director here at Fidelity, made his five ISA fund picks for 2021 earlier this year, he knew he wanted some exposure to the UK. He felt our home market, for so long now out-of-favour with investors, may finally be on the cusp of a vaccine-fuelled comeback.

The question Tom then faced was how best to play that comeback. Specifically, he was torn between investment styles. He wasn’t sure whether the ‘value’ approach to investing, which involves looking for companies you feel are trading below their true worth, or the ‘growth’ approach, which looks to buy stocks with unlimited growth potential, would do best this year.

As such, Tom decided to recommend one fund for each style - diversifying his pool across styles like this means he’s able to capture the upsides of both while protecting against potential downsides. It means he keeps his eggs in more than one basket, even if they both carry a distinctly UK flavour.

For his value pick, Tom has gone for the Fidelity Special Situations fund; for growth, the Fidelity UK Select.

Tom recently met with the managers of both funds to discuss their outlooks for the UK and their fund.

Fidelity Special Situations Fund

Alex Wright, the manager of Fidelity Special Situations, is a classic value investor. He says: “I like looking at things that are unfashionable which other investors aren’t really excited about. I think that if you’re looking at an unfashionable sector, and fewer people are looking at that sector, there’s more chance of you getting an edge by doing the deep research there.”

Wright’s value bias, combined with the wider underperformance of the UK market in recent years, has seen his fund struggle in a market that has favoured international growth stocks.

However, Wright thinks that things may be about to change.

In his eyes, there are two reasons for the UK’s under-performance in recent years. The first is Brexit. Markets hate nothing more than uncertainty, and our protracted divorce from the EU left the UK’s prospects dubious for the best part of five years.

The UK also fared particularly poorly during the pandemic. The sort of sectors that make up the bulk of our market - industrials, financials, retail, services, and so on - were the ones that suffered worst amid lockdowns.

Fortunately, both Brexit and the pandemic could soon be behind us. In fact, as Wright points out, conditions have already started changing in favour of his fund. Over the past six months, a period which has delivered both a Brexit deal and remarkable vaccine progress, UK companies have outperformed the US, with value stocks faring better than growth.

All this means that, in his eyes, “things are really looking up from a macro perspective.” A rotation away from the pandemic winners to the sort of “cyclical”, value-orientated stocks that suffered worst, should suit an “anti-momentum, contrarian strategy” like his more than most.

One sector which could benefit especially is the financial sector, a classic value hunting-ground which features heavily in Wright’s portfolio. It ticks many of Wright’s contrarian boxes: financial companies have been largely out of favour since the 2008 crisis and operate via complex business models that most investors don’t attempt to understand. Yet despite their unpopularity, financials can make for “very good companies”, according to the manager.

Stocks like these - ones that are overlooked by the wider market, but still retain their fundamental quality - offer the sort of “edge” he’s looking for.

As he explains: “It’s not buying bad companies. It’s buying companies that people perceive as being bad today because of something that has clouded their judgement.”

Fidelity UK Select Fund

Tom’s growth pick is the Fidelity UK Select Fund, managed by Aruna Karunathilake.

Karunathilake agrees with Wright that the UK’s woes can be attributed to Brexit and the pandemic, which have combined to cast a “long shadow” over our market.

And, like Wright, he too is optimistic: “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.”

But from here, the similarities between the managers end. Though his fund is less explicitly growth focused than Wright’s is value, Karunathilake’s bias for “quality” companies naturally draws him to high-growth names.

He likes companies with a strong brand, or “moat”, which keeps the competition at arm’s length. He cites Burberry, whose famous 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.

And while the UK’s pariah status has made life difficult for a UK fund manager, he’s enjoyed picking out opportunities this period of disfavour has offered up.

When we spoke to the manager around six months ago, he said “patient investors should consider building a position while evaluations in the UK remain favourable”. That’s exactly what Karunathilake has been doing.

He explains that he 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”.

That focus 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.

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.

Same market, different approach

Both Wright and Karunathilake agree that now could finally be the time for the UK to reclaim its time in the sun. But that’s only part of the story. Knowing how best to play our market’s recovery is where things can get tricky. If, like Tom, you want exposure to both sides of the story, these two funds offer an easy way to diversify your UK exposure across investment styles.

More on Fidelity Special Situations Fund

More on Fidelity UK Select Fund

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 invests in a relatively small number of companies, so may carry more risk than funds that are more diversified. The Fidelity Special Situations Fund and Fidelity UK Select Fund may invest in overseas markets, so the value of investments could be affected by changes in currency exchange rates. The funds use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The funds 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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