22 Jun 2020
Aruna Karunathilake 15/06/2020
As the UK starts to emerge from lockdown, Fidelity UK Select Fund portfolio manager Aruna Karunathilake discusses how investors should approach the gradual reopening of the domestic economy. He outlines how easing back into normality will affect different sectors, why he’s feeling more positive on oil and how he’s positioning for Brexit.
It’s been three months now since Fidelity has been working from home. I am settled into my new office in the loft reading research and checking in with company management while Sid, my ginger cat, dozes next to my screens. Although I miss “real life” interaction with colleagues, a combination of Zoom calls and messaging systems mean I feel as connected to the Fidelity knowledge bank as I always did.
As we look ahead, I think we now have a good idea of when businesses are likely to restart operations in the UK and my focus has therefore shifted to thinking about how companies will fare in the ‘new world’. As business look to reopen, what does a socially-distanced world look like across the backdrop of recession and economic uncertainty?
For investors, it is clearly vital to differentiate between companies that can prosper in the current environment from those that will struggle. You need real in-depth research into individual companies to identify winners and losers - analysis that I rely heavily on from our pool of investment experts across the business.
When assessing the retail sector, for example, we know that companies will have to dramatically change the way they operate in a socially distanced world. Shops will need screens around tills, one-way systems and more staff to coordinate social distancing. Customer numbers will be limited and once inside people will shop quickly for what they need instead of lingering to browse out of respect for those queuing behind them. This will impact some retailers more than others as consumer behaviour is altered and shopping patterns change.
Take a former holding of mine, Card Factory, who heavily rely on a lot of people coming into store and spending small amounts of money. Customer spending patterns may change as people no longer spend time browsing or visiting shops as often.
Contrast this with another former holding, Burberry, which relies on just a few people coming into store but spending money on big ticket items. Even with social distancing in place, shopping habits are unlikely to be impacted. Early feedback from our analysts in China and Korea is that luxury sales are already up compared to last year in some recently reopened stores. It’s this level of insight that means active stock pickers have a chance to shine in this environment, as we closely navigate and allocate to opportunities.
My investment process and philosophy are built on a scoring system that looks at; business fundamentals, valuation and franchise quality to evaluate the attractiveness of a stock. The turnover of the fund is a function of the change in these scores - if nothing changes, I sit on my hands but if things change then I do not hesitate to act.
Given the Brexit merry-go-round coupled with Covid-19, the fundamental and valuation scores have been changing more than normal and as a result, fund turnover has picked up from c30% to c50%. One stock I recently reduced exposure to was catering group Compass which I have owned since 2009. Despite being an extremely well-run business, restaurants will likely be one of the worst hit industries, given the extra cost and lower revenue they will face in a socially distanced world.
As a quality-focused investor, valuations are the cornerstone of my investment style. In recent years, we have seen a huge inflation in the price of some highly desirable UK equity stocks. Apart from the opportunity to spend more time with my family, the only good thing about the Covid-19 crisis has been the opportunity to buy back into some great businesses at reasonable valuations. I have reinstated positions in Burberry and Hargreaves Lansdown at very attractive prices, as well as increasing exposure to Intercontinental Hotels, St James Place and Renishaw. All high-quality businesses with excellent returns on capital defended by a strong moat.
I have also become more positive on the oil sector than I have been for quite some time. Supply has responded quickly to lower prices through the re-establishing of cooperation between Russia and OPEC, in addition to marginal [high cost] supply being curtailed elsewhere.
While demand remains low and stockpiles high, I think the worst of the demand destruction is over and the most money in the stock market is often made when things go from awful to less bad. I have topped up my holding in Pioneer Resources and initiated a new position in a non-UK listed producer.
As we creep towards the 30 June deadline for an extension to the Brexit withdrawal agreement, precious little progress seems to have been made during the pandemic. As investors, I think it is important to consider the possibility of no extension and a rudimentary “no deal” agreement in December. Lack of progress in negotiations has dampened my enthusiasm for the UK-facing areas of the market and exposure to domestic revenues in the portfolio, while still overweight, has been reduced.
Markets have come a long way since I last wrote, with the Fidelity UK Select rebounding strongly but is still down over 12 months. While valuations are less attractive than they were in March, plenty of opportunities remain for us to identify strong companies that can adapt to changing circumstances and thrive whatever path the virus and economy take.
In my view, subsequent waves of infection will be better managed and should have less economic impact than the first wave. Our healthcare professionals have more experience, PPE provision and track & trace will improve. So, although the virus won’t change, we are better prepared.
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. The Fidelity UK Select Fund has the potential of having high volatility due to the concentrated nature of the portfolio. It can also use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. 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.