29 Jul 2026
UK equities continue to trade at attractive valuations despite an improving market backdrop. At the same time, artificial intelligence is reshaping industries and business models, reinforcing the importance of disciplined stock selection and careful attention to valuation. Here, Alex Wright, Portfolio Manager of Fidelity Special Situations and Special Values, discusses where he continues to find opportunities across the UK market.
UK equities recovered during the second quarter as improving risk appetite and resilient corporate earnings supported a broad market rebound. More domestically exposed and cyclical areas of the market also recovered, with mid and small caps participating more meaningfully after a prolonged period of underperformance.
Despite renewed geopolitical uncertainty, we continue to see compelling opportunities across UK equities. Valuations remain at a significant discount to other developed markets, and we continue to find companies where the market has become overly pessimistic and where we believe positive change is not yet reflected in share prices.
Our investment process remains focused on identifying companies that other investors have overlooked, misunderstood or simply given up on. Importantly, however, we are not simply buying cheap companies and hoping valuations recover - the focus is on understanding why a business has fallen out of favour and identifying potential catalysts that could drive a recovery over time.
Artificial intelligence is becoming an increasingly important consideration across equity markets. While there are relatively few UK companies that currently benefit directly from the build out of AI infrastructure, we believe AI is increasing uncertainty across many parts of the market.
The portfolio has exposure to businesses that are benefiting from AI related investment; Keller, for example, continues to benefit from demand linked to data centre construction in the US. At the same time, we are closely assessing businesses whose competitive positions could become more uncertain as AI develops and where the market has become overly pessimistic, creating an attractive entry point.
However, companies such as RELX, Experian and Sage have historically traded on premium valuations because of their strong market positions, high returns on capital and attractive margins. They may continue to be successful businesses, but we believe AI has made their long-term competitive positions less certain. In our view, the market has yet to fully reflect this broad level of uncertainty into valuations.
Overall, we expect AI to improve productivity over time. However, those productivity gains are also likely to bring greater disruption across industries. While many businesses will continue to thrive, we believe investors should be more cautious about paying premium valuations where future competitive advantages have become less predictable.
Against this backdrop, we continue to focus on companies where valuations already reflect a high degree of pessimism, but where we believe the market is underestimating the potential for positive change.
While financials remain one of our highest conviction areas, we continue to find opportunities across the market where investor expectations have become overly pessimistic. Banks account for almost 20% of the portfolio, and we have added modestly to large domestic banks as valuations have become increasingly attractive. Within what we regard as a normal interest rate range of around 2% to 6%, banks are capable of generating returns on capital in the high teens. Yet many continue to trade on valuations of only seven or eight times earnings. We continue to see attractive opportunities across holdings including Lloyds, NatWest, Standard Chartered, AIB and other banking positions. We also believe many investors continue to underestimate the quality of these businesses.
The same disciplined approach is creating opportunities elsewhere in the market. Smith & Nephew is one example. While the orthopaedics business has struggled for many years, we believe the market has become too focused on that part of the business. Its other two divisions now account for around 70% of group profits and continue to perform well, while stronger cash generation has enabled the company to undertake share buybacks as operational improvements continue.
We also continue to find opportunities where near term concerns appear to outweigh longer term fundamentals. Recruitment companies such as Hays, PageGroup, SThree and FDM have experienced a prolonged downturn in hiring activity, while investor concerns have increasingly focused on the potential impact of AI. However, we have yet to see evidence that AI has structurally impaired the staffing industry. In our view, the challenges facing these businesses remain largely cyclical rather than structural, while current valuations already reflect a high degree of pessimism.
Recent takeover activity also reinforces our view that many UK-listed companies remain undervalued. During the quarter, DCC received a takeover approach, illustrating the continued interest from strategic and private equity buyers in attractively valued UK businesses. While individual transactions can provide a catalyst for performance, they also reinforce the broader valuation opportunity across the UK market.
The near-term environment remains uncertain, and we continue to monitor the impact of higher energy prices and geopolitical developments. However, our focus remains firmly bottom-up, and periods of uncertainty often create greater divergence between individual companies, providing more opportunities to identify businesses where valuations do not reflect the potential for positive change.
Our approach remains unchanged. We continue to build a diversified portfolio of companies at different stages of recovery, seeking businesses where positive change has yet to be recognised by the market. We believe that combination of company specific opportunities, disciplined valuation and the significant discount that persists across UK equities continues to provide a compelling opportunity over a three to five year investment horizon.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. The Fidelity Special Situations Fund and Fidelity Special Values PLC can 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. Investments in smaller companies can carry a higher risk because their share prices may be more volatile than those of larger companies. The shares in the investment trusts are listed on the London Stock Exchange, and their price is affected by supply and demand. The investment trusts can gain additional exposure to the market, known as gearing, potentially increasing volatility. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities but is included for the purposes of illustration only.
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