QROPS Advice: Investment News: Playing with BRIC's

Sanjeev Shah, fund manager of the Fidelity Special Situations Fund, buys into the longer-term emerging markets story, but does not believe that commodities are the best way to play it.
Playing the BRICs
"I am not a believer in the commodity story and have a more negative view than some on the demand/supply balance for commodities," says Mr Shah. "Leaders in the first part of a bull phase are rarely in that position in the next phase."
Mr Shah regards mining stocks in particular as "value traps" on the grounds that there is potentially a lot of momentum in the name, but their valuations are not supportive. "The price to book ratio on these stocks is at a 50-year high driven by sentiment because of their emerging market exposure," says Mr Shah. "I only think that a stock is a good investment if it has long upside potential, and in the case of miners it is not there."
As oil stocks, in particular exploration and production companies, did well in the early part of 2009, Mr Shah reduced holdings.While he still has some exposure in this area, given that valuations here are better than for miners, he adds: "I do not have a high level of conviction on this for 2010/11, as the stock market has re-rated a lot of commodity producers to historically high extremes. For emerging markets exposure I prefer to buy franchises outside the commodity s pace."
Examples include FTSE 100 advertising and communications agency, WPP, which Mr Shah says generates around 28 per cent of its revenue from the BRIC economies (Brazil, Russia, India and China). WPP has also not participated in recent equity rallies, and fits in well with Mr Shah's investment approach, which he describes as a "strong contrarian philosophy".
Identifying special sits

Mr Shah identifies a special situation by keeping his focus on valuation anomalies - stocks which he considers to be materially mis-valued - 25 per cent or more. "I look for stocks unloved by the sell side and other investors, and opportunities which represent recovery situations," he explains.

This will often include mis-priced growth, takeover potential or a hidden aspect, which could include an unnoticed division within a company, or an aspect of its business model and how it is developing. "Yell is perceived as a print directory, but 25 per cent of its revenues comes from online activity, while it also provides leads for small businesses," says Mr Shah.

In terms of merger and acquisition activity (M&A), there could be some opportunities ahead. "M&A is at historically low levels, but there are improvements such as the availability of financing via debt markets. I expect there will be more appetite," says Mr Shah. "Examples of stocks which could be taken over include online gaming stocks."

Special situation investing can often mean a sacrifice of shorter-term returns, as companies take a while to turn around. In 2008, the Fidelity Special Situations outperformed its peers in the UK All Companies fund sector as well as the FTSE All-Share. However, in 2009, the fund got left behind with just under 29 per cent - as opposed to 30 per cent for the sector and All-Share.

Over the last year to 20 January, the fund is ahead with nearly 45 per cent, compared to 38.8 for the sector.

Favourable conditions

Mr Shah adds that while the fund's mandate and flexibility allows him to adjust to different market conditions, at present the environment is very good. "This is because valuations are still cheap relative to history, although they were much cheaper in 2009, and investor sentiment is still negative. There are some good bottom-up opportunities and we are finding things we like," he says.

The fund has a large position in media stocks which accounted for nearly 18 per cent of assets at the end of November. "These had been weak for around 10 years because of the online threat and fragmentation," says Mr Shah, "but BSkyB and Pearson offer growth at a reasonable price, while Yell is a recovery situation".

Mr Shah also sees some good organic growth potential among certain technology stocks in which the portfolio is overweight. "Technology had its own crisis during the tech bubble at the turn of the Millennium, but has done better in this crisis because these companies' balance sheets are now robust. Among small caps, I own around 8 per cent of Kofax, while I also hold mid-cap Logica (one of the fund's largest holdings), which has turned around under new management and could be involved in takeover activity."

In late 2006, Fidelity Special Situations gained Ucits III powers to use derivatives. Mr Shah comments: "Special Situations is a long only fund in the main, however, through using derivatives selectively I have added value. I short individual stocks and am short on 10 in the portfolio currently, which account for around 5 per cent of the overall value of the fund."

At times, such as early 2008, Mr Shah will also buy put options and has shorted the mid-cap index. He says: "If I become more negative I will do this again, but do not plan to do it at this moment in time."

by: Leonora Walters