21 Nov 2018
The Fidelity Global Special Situations Fund invests across three distinct categories of investments - unique businesses, corporate change and exceptional value - with the aim of building a flexible and stylistically balanced overall portfolio.
Growth stocks are those companies that have the potential to deliver an annualised return of at least 15% by generating high expected profit growth on the back of their market dominance, niche positioning in growth industries and pricing power. We expect to hold stocks in this category for at least three years.
Looking back at the post crisis period, growth stocks have appealed to investors in an otherwise low-growth world and have also done well for the portfolio overall. It has become an established view and almost a truism that investing in growth is what must deliver the best returns over the long term - and in many ways, it has been difficult to argue with that on a backward-looking 10 year view.
A lot of the growth we have seen has come from technology companies and the disruption they have unleashed. Such businesses have offered better products to the marketplace, begun to reach a wider global customer base, deliver faster and more efficiently, and drive down costs.
As they have found ways to take a greater and greater share of the value chain, they have also created an obsolescence risk in other sectors and industries. In a world with low growth and bond yields, investors have valued the future earnings of technology businesses at low discount rates, making their future earnings more and more valuable.
In many cases, these companies have delivered handsomely. Margin improvements have come from more consolidated industry structures and network effects, as well as cost improvements driven by globalisation and faster, smaller and cheaper physical components. This has supported the growth-investing hypothesis and fuelled further re-rating. However, there are some signs that the market’s “animal spirits” and enthusiasm for new technology players may have gone too far.
Last year we heard a lot about the inexorable rise of the big internet players in the US and China. The shares in these companies all rose strongly. The “BAT-FAANG” moniker for this group of stocks indicated that people were lumping them together without paying enough attention to the very significant differences in these businesses.
Things have changed this year. The Chinese names have slumped and in the US there has been great divergence with, for example, Facebook falling significantly in the first 10 months and Apple moving sharply in the opposite direction until very recently. This should be seen as a healthy development. The true long-term margin potential of such businesses should now be debated, given that even the large incumbents carry their own set of obsolescence risks.
There are also legitimate questions amongst investors about which growth areas could be expected to pick up the slack from any slowdown we see in technology. The traditionally more defensive consumer staples sector has seen its reputation for steady growth dismantled in recent years. Demand for branded consumer goods is waning, there is increased disintermediation from online players and consolidation in value chains. In this context, the growing pains we have seen recently are not unexpected.
We have approached growth via the unique business category but have found investments across a variety of industries. While the fund has benefitted from its exposure to technology stocks over the past several years, we have had exposure to niche businesses with growth prospects in areas such as health care (Cooper Companies), consumer discretionary (Walt Disney), financials (Deutsche Boerse) and renewable energy (Orsted).
The technology sector has certainly been an interesting one to navigate, particularly in the last 18 months or so, when some valuation premiums have become difficult to defend. Instead of capitulating to the momentum and buying names with the most visible growth characteristics, we have followed a strategy that had worked in the late 90s, during the dot.com era, when we believed that enthusiasm for such names had somewhat lost touch with reality.
Instead of buying the more expensive larger stocks we have instead focused on second tier companies, aiming to identify more attractively-valued future leaders benefitting from the same long term structural growth opportunities.
In recent months, we have reduced the semiconductor names more vulnerable to a downturn and trade-related issues, and have honed in on companies with recurring revenues and cash flows that can deliver less cyclical growth, such as Microsoft and Visa. As ever, the US provides the broadest and deepest selection of good growth companies, masses of innovation, highly motivated managements and remains a prime hunting ground for opportunity.
Recent additions in the portfolio’s unique business holdings have gone beyond the technology sector, including the likes of Concho Resources, a US E&P focused on the Permian region. The company is expected to benefit from production growth and improved operating efficiencies. In Europe, biotechnology business Genmab gains from a growing royalty stream from its best in class multibillion dollar blood cancer drug Darzalex and has a number of pipeline opportunities in clinic and pre-clinic development.
Elsewhere, recently purchased insurance company AIA remains very well placed to capitalise on the strong long-term growth potential in life and savings products in Asia. The company is unique amongst non-domestics in that it operates within China through a wholly owned vehicle and expects some of the restrictions it faces geographically to be removed within the next few years.
As ever, it is the work of our team of global equity analysts that proves invaluable in the task of identifying “long-term winners” in their industries. In making portfolio investment decisions we have focused first on stock-specific fundamentals while also keeping on top of wider industry trends. This is consistent with a process that has worked well for our clients in the past and is expected to deliver in the future.
Jeremy Podger, Fidelity Global Special Situations Fund.
This article is for investment professionals and should not be relied upon by private investors.
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