Key Takeaways
- Gold-Rated Fidelity Special Situations fund manager says pace of UK acquisitions isn’t a concern—the lack of IPOs is the real problem.
- Wright, who holds financials and banks in his portfolio top 10, says these businesses will remain “attractive” while interest rates remain above 2%.
- The manager says he is “nervous” about AI because technology valuations don’t reflect the uncertainty now baked into all AI-exposed businesses.
Ollie Smith: Now, it would be fair to say that the words “special situations” feel more relevant than ever in 2026. So it’s about time we sat down with Alex Wright. Alex is manager of Fidelity’s Special Situations fund, which has a Morningstar rating of Gold and also won in its best UK Equity Fund category at the Morningstar Awards for Investing Excellence back in March. Alex, thanks so much for your time today.
Could we just start with valuations? We’ve obviously seen a significant period of turbulence in the first half of this year with the Iran war and its consequences. How on earth are you positioning this fund for the second half?
Alex Wright: So as you’d expect, the fund doesn’t change dramatically between six-month periods. So average turnover of the funds may be 25-30%. So [we’re] still very much as we were towards the start of the year in terms of financials being the biggest weight in the fund and particularly in the banks, where we’re overweight and indeed, at the margin, we had been slightly adding to that. So almost 20% of the fund is in banks. But also we’re not just in those more cyclical areas. We have lots of other ideas. And indeed that is to make sure that we’ve always got a diversified portfolio.
We’re looking for individual change stories: 80 to 90 names in the portfolio as a whole. And that allows us to go right down the market cap spectrum to some of the small-cap areas. The fund is very diversified, [with] both UK domestic earners, which make up sort of 35- 40% of the portfolio, but [also] more than 60% as international earners, including some of the the big things like Total TTE in oil, AIB AIBG in banks in Ireland, and Standard Chartered STAN in banking in Asia. So while it’s obviously an investment in the UK market, that does actually give you a subset of the global economy in there as well.
Why Fidelity Special Situations Fund Is Overweight Banks
Smith: Sure. And just in terms of being overweight financials, there’s still significant uncertainty surrounding the trajectory of interest rates. So, you know, what’s your ideal outcome when it comes to banks?
Wright: Well, I guess the beauty of the banks is that within a normal interest rate range, which I’d say is sort of between about two and 6%, the earnings of the banks aren’t that variable. So that is a great range for banks to be able to produce high-teens returns on capital. So that makes them quality businesses, and they’re not priced as quality businesses. So you’re certainly seeing those high-teen returns from the UK domestics like Lloyds LLOY and NatWest NWG but also increasingly from Standard Chartered STAN as well, and yet you’re trading on [pence].
When we look to 2028, and that’s only two years out, [you’re looking at] about seven or eight-times earnings. So that’s why I’m still really excited by the financials, because you’ve got good returns, good returns that aren’t that variable within that range, but it’s still very low valuations. Now obviously outside of that range is a risk. So sub-2%, it’s very difficult to make margins on current accounts because you can’t charge people. And then [at] above 6% people have problems paying back their loans. So I think interest rates within quite a wide band are okay. I don’t see a world where we get back to sub-2%. I think a lot of the deflationary forces, that led us to be there post-GFC, not just the deleveraging of the banks, which is definitely over, but also the globalization, China’s entry to the World Trade Organisation, and deflation from China—again, that has gone away with things like covid and geopolitics. So I think as long as interest rates stay above 2%, the banks still look really well placed.
Why the UK Stock Market Needs More IPOs
Smith: Interesting. I’m mindful of what you’ve just said about two years not looking like it’s that far away. It’s 10 years this year since Brexit and, you know, one of the things that’s happened in the last 10 years is there’s been significant acquisition activity within UK markets. That’s been one of the big stories. One fund manager we’ve spoken to that said that if that pace continues in the next 10 years, there won’t be a UK stock market left. So I just wonder from your perspective, taking a step back and looking at this picture as a whole, do you see the pace of acquisitions within UK PLC as being a good story or a bad one?
Wright: Well, it’s overwhelmingly a good one in terms of performance. Indeed, you can see that year-to-date: our best performer is also our biggest stock, DCC DCC, which has received a bid. That’s a live situation so we can’t talk anymore on it, but I think that shows the undervaluation of the market. Now, what normally happens in a well-functioning market is you get IPOs on the other side sort of back-filling. And so I think it’s that story, the lack of IPOs, which is problematic because I think that maths is not far off on a 10-year view. If there aren’t any IPOs, that’s going to be problematic for the UK market. That said, it’s not that long ago that there were quite a lot of IPOs. So like 2021 and the first part of ’22, there was an absolute bumper load of IPOs through covid after the market had an incredibly strong recovery from covid. So that is now five years ago. So I think five years without IPOs is okay. 10 years isn’t really.
Smith: Yes, that’s very interesting. And of course the big IPO of the year has been SpaceX SPCX very, very recently. Are there any lessons that you think UK fund managers or UK-focused fund managers can learn from that aside from the need for more IPOs?
Wright: To be honest, that’s as I said: I focus on stocks available in the UK or occasionally near to the UK like some of our European holdings. So I don’t have a view on SpaceX specifically. You’d have to talk to our global managers for that one.
Why Fidelity Bought Smith & Nephew Despite Years of Underperformance
Smith: Let’s just talk process a second, because one of our analysts says that you are a highly “disciplined” fund manager. It strikes me that with companies like Smith & Nephew SN., which are in the portfolio or have been in the portfolio, but are also some of those highly-shorted stocks by other traders and investors, there is a need for discipline there, but I wonder how you manage the risk of a company’s performance not recovering.
Wright: Yeah. So Smith & Nephew is a great one because you’re right, I use highly-shorted stocks as a screen. So I look at other companies that are shorted as a contra-indicator because, if you think about it, those funds which are short are a “force buyer” at some point. So, again, no one has to buy a stock, but if you’re short, if you don’t want to make the position, you have to. So if things change positively, I tend to find that stocks that are highly shorted work much more quickly than those that aren’t highly-shorted, because you’ve got those people consistently monitoring it. And so it’s really key for me to know what the counter-thesis is like. Why are these people short? Is it on a time horizon? Maybe they’re just thinking about the next quarter, whereas we’re tending to look at the next three to five years. And also: are they looking at the industry as a whole compared to the company itself? So again, we’ll quite look quite often look at industries that maybe aren’t high-growth, but where a player can take market share. And then also are they focusing on one particular part of the business.
So I’d say that’s particularly the case with Smith & Nephew. Why were we so interested to buy what has been touted for 20 years as a perennial turnaround and hasn’t turned around? That’s because the part of the business that hasn’t turned around has done so badly on a 20-year view, it’s got to be only a third of profits. So is there a risk around that part of the business turning around? There definitely is, because this business has been a perennial under-performer over a perennially long period of time. But I think what people have missed is that the other two parts of the business have become 70% of the profits, and those are good-quality businesses, which are continuing to grow. And then importantly, also the cash generation of the business, again, partly because this problematic “ortho” business has become smaller, has got better. And so for the first time ever, they’ve been able to start doing share buybacks. We look for that on the downside. So a bit like on the investment trust that we run [Fidelity Special Values]: if the fund’s out of favor and we go to a discount, we can add value by buying back stock, and that’s the same on undervalued stocks that produce cash. I really like that. On the downside, that’s the discipline we’re looking for: it’s like, yes, if things go wrong how big a problem is it? So how big a problem is that part of the business, and then what can the company itself do help stop the company continually going down? So share buybacks are a key thing we look for.
Why Alex Wright Avoided RELX, Experian, and Sage
Smith: Sure. And just finally, we’ve talked a little bit about SpaceX. I just want to finish on the topic of AI. Does AI keep you awake at night? What’s your assessment of how positively or negatively the fund is exposed, so to speak, to AI and that revolution?
Wright: Yeah. So I think AI is really interesting. While there are very few companies, I would say in the UK that benefit directly from AI in terms of the current build-out. So there are a few, a bit like Keller KLR that help build data centers in the US, or Mitie MTO that helped build them in the UK, or maybe the grid companies like SSE SSE and National Grid NG. We’ve sold out of National Grid because it’s done so well because of electricity use.
Actually in the UK market, what there is quite a concentration of is companies that might be disintermediated by AI. And so we’ve done very well by not owning RELX RELX, not owning Experian EXPN, and not owning Sage SGE: companies that are on very high multiples and are priced as monopolistic businesses: so very high return on capital, very high margins, pretty good top line growth, a lot of it from pricing. And now if you think about it, those businesses are ripe for disruption because of those characteristics. So huge profit pools, very high returns on capital. So if you’re going to try and go after something that’s something you want to sort of go after. If you’re AI and you can sort of write software code much, much more cheaply and much more easily. So to be honest, we’ve been out of those because they were at high valuations rather than being out of them because of that risk.
Why AI Should Mean Lower Stock Market Valuations
Actually if you think about what AI means, it makes everything more uncertain. So to me that means valuations of everything should be lower because with certain, well... People were pricing with certainty that RELX was still going to be a great business in 10 years time and [were] therefore willing to pay 30-times earnings. It may still be a great business in 10 years time, but I just don’t think...you know...there’s a lot of businesses like that. So what you really need to do is pay a lower multiple for that. And I don’t see the market as a whole doing that. So that makes me nervous about markets as a whole, because valuations aren’t reflecting this uncertainty.
So I think AI is probably going to be great for growth. It should improve productivity. But the way it’s going to improve productivity is in increasing disruption. Why has productivity been weak? Well, that is because there’s a lot of areas that have become monopolized by information: businesses that make very high returns [that] effectively charge a rent for those areas, which may get broken down. So that’s exciting from a global growth perspective, but it’s pretty scary from a global stock market point of view.
Smith: Sure, Alex, thank you so much for your time. For more on fund managers and Morningstar fund manager analysis, check out Morningstar.co.uk, where you can sign up for our new revamped weekly newsletter. Until next time, my thanks to Alex, I’ve been Ollie Smith for Morningstar.
