Under the management of Sanjeev Shah, Fidelity's UK Aggressive Fund has performed strongly in a ferociously competitive sector to rank in the top 20 of 277 funds
When Fidelity's Sanjeev Shah is searching for investment opportunities that will help ensure his UK Aggressive Fund continues to deliver strong outperformance in all market conditions, he focuses on five key areas.
The rising fund management star looks for turnaround situations, signs of potential corporate activity, unrecognised growth potential, mis-valuations relative to peer group and overlooked divisions within companies as part of his detailed analysis.
And he believes this unique approach to portfolio construction, with its distinct value orientation, enables him to find the right combination of companies to produce the absolute returns which are demanded by his clients.
"It's a pure stockpicking fund with a focus on absolute value," explains Shah. "My philosophy is that 95% of the stock market is fairly valued so I am trying to filter out the 5% where there might be a potential market anomaly relative to what I think the business is worth."
Shah's approach certainly appears to work - as analysis of the returns achieved since he took charge of the portfolio in the Autumn of 2002 will testify.
The fund has delivered a very impressive return of 58.69% bid-to-bid, net income reinvested, between October 14th, 2002 and October 11th, 2004, which is well above the 35.41% average for the UK All Companies sector, according to data compiled by Standard & Poor's.
That performance is enough to place it 20 out of 277 rivals, which is no mean feat - especially in a ferociously competitive sector which features such recognisable names as his Fidelity counterpart Anthony Bolton's Special Situations Fund.
Over that same period, UK Aggressive has also comfortably outperformed the benchmark FTSE All-Share index which has returned a far more modest 32.13%.
By any measure, that is a highly impressive performance. The fact that it has been achieved by someone who has only been a fund manager for two years, however, is an even more remarkable achievement. As is the Fidelity way, Shah was promoted up through the ranks - after spending six years as an analyst - because senior executives within the investment house recognised that he displayed tremendous potential.
His career with the company began in 1996 when he joined as a research analyst and cut his teeth following the food, retail, media, pharmaceutical and telecom sectors.
In 1998 he became assistant portfolio manager to the UK income funds, before being given a shot at managing a fund himself, taking over UK Aggressive four years later.
Not only has his performance vindicated Fidelity's decision to promote him, it has also been recognised externally. Earlier this year, the fund received a public seal of approval when Standard & Poor's awarded it a coveted A-rating.
The ratings agency praised Shah's success in meeting challenges in the face of "fierce" in-house competition and said he had provided consistent outperformance.
"Shah demonstrates evident ability and focus, which have produced consistent, strong outperformance over 18 months," read the report.
The overall purpose of the fund is to outperform the market consistently by delivering a higher return than the FTSE All-Share index.
Shah is keen to stress that the term "aggressive" actually refers to its stockpicking focus and insists that any perceptions of the fund being a risky product with a sky-high turnover are very wide of the mark."It is not a concentrated fund as I do have a range of names within the portfolio," he explains. "I would describe it as a go-anywhere product which isn't constrained by the benchmark which allows me to scout out opportunities across the small, mid and large-cap sectors, as well as abroad."
Currently there are approximately 100 stocks in the portfolio, which hail from a broad cross-section of industries. Financials is the largest sector, accounting for 28.5% of the fund, followed by services with 23% and energy with 14.4%.
Within the portfolio, BP is the largest holding with 10.1%, followed by Shell on 3.8%, GlaxoSmithKline on 3.2%, Aviva with a 3.1% share and 3% in Standard Chartered.
To find the stocks in his portfolio, Shah adopts a very methodical approach. Two or three days at a time will be spent closely examining a sector with the use of internal and external analyst notes, valuation tools, earnings estimates and charts.
"Most of my process involves screening out ideas then doing all the due diligence and meeting with divisional management," he explains. "Those company relationships are important to me to build up conviction levels on stocks."
Shah will actively screen for stocks which have a strong absolute upside potential of between 25% and 40%. If they succeed and that potential narrows, then the position they occupy in the fund is reduced. When the possible upside is 10% or less, the chances are that a holding will be sold completely.
A crucial factor in this investment decision process is the famed research capability of Fidelity, which has more than 50 analysts in the UK who spend every day of their working lives closely following pan-European sectors.
Further analyst teams in the company's US and Asia offices also help Shah by giving him an insight into global trends which may be emerging on both a sector-specific and more macro level.
The task of finding mis-valued UK performers, however, has become more difficult since the market bounced back in such spectacular fashion during 2003. This trend of diminishing numbers of mis-valuations is expected to continue over the coming months.
It's a prospect which has led him to capitalise on the fund's ability to invest an element outside the UK, which multiplies by five the number of potential companies which can be bought.
"I did not really use this utility at first because I wanted to focus 100% of my energies on UK stocks but I started to look elsewhere from the middle of 2003," explains Shah. "Expanding the investment universe allows me to generate new ideas."
This capability to invest a proportion of the fund overseas has delivered handsome returns in recent months.
"The statistics for the last quarter show that non-UK companies were the chief contributors to fund performance," reveals Shah. "I only look outside of the UK when there is a better potential opportunity abroad. Also, the markets in Europe are less efficient and the stocks there are not so well covered."
Crédit Agricole, a restructuring story in the French banking sector, has been one of the fund's star names in recent months. "I like having a wider universe from which to select," says Shah. "I find it more difficult choosing from 600 than 3,000. If you know what you're looking for it just provides you with more choice. My entire process revolves around weeding out the best names in the UK and Europe."
The selection process adopted by Shah is focussed on five key investment areas.
The first is defined as turnaround and recovery stocks where either the existing assets have been mis-priced or the business has been through a down cycle in its markets but is displaying the potential to bounce back.
A prime example over recent months, says Shah, has been the French car manufacturer Peugeot.
"The company went through a very tough period between 2001 and 2003 as they didn't have any new products, French consumer confidence was deteriorating and the exchange rate was against them because sterling was depreciating against the euro," he recalls.
"However, I could see that the product cycle was turning and wanted to be in a stock which would be a beneficiary of sterling strength."
Second is corporate activity. "This is where I wear the hat of a predator and try to pick which companies I would like to acquire in different sectors and work out how much I'd be prepared to pay," explains Shah. "One stock in the fund at the moment which may be a potential acquisition target is Matalan." Finding companies with unrecognised growth potential - instances where the stock market is mis-valuing the time horizon over which growth can take place and its extent - is another vitally important area.
Shah cites MTN, a mobile phone company with a core franchise in South Africa, as a stock which exemplifies this genre.
"You are playing the rising penetration of mobile use in Africa at a significantly lower multiple than its peer group," he explains. "It has a decent management team, a conservative balance sheet and the possibility that a western mobile company may look for a franchise in Africa."
Next up are companies which are mis-valued relative to their peer group. These firms may be in the same industry and display broadly similar business dynamics, but for some reason the stock market has misunderstood the story. The Diploma Group in the support services sector, adds Shah, has been one of the best recent examples. Finally come divisions or assets within a company which have been overlooked by the stock market. Shah often describes these as "company jewels" and says the Simon Group illustrates the point perfectly.
Among the benefits presented by owning shares in the port and logistics operator, he explains, is the fact that its business is focused on operations at the Humber Sea Terminal on the Humber estuary and at Port Sutton Bridge on the Wash.
"The changing regulations in the UK governing road haulage and the number of hours drivers are allowed to be on the road have helped the company," says Shah. "It does not make sense to start unloading cargo down in Southampton and drive it all the way up the country when they can dock in a port on the Humber."
The fund's performance has been acknowledged by investors: a fact clearly illustrated by the millions of pounds which have been pouring in since Shah began stamping his authority on the fund.
"When I took over, the fund was at £70m and today it's £175m," he says. "I would say half of that has been absolute performance and half has been in-flows."
The prospect of managing higher sums doesn't faze him. "Clearly my style and approach are going to evolve as more money comes in," he says. "Two years ago the prospect of managing £500m would have daunted me but now I'd feel a lot more comfortable evolving with the growth."
The fact he has been managing a high-profile fund during one of the most volatile periods in stock market history has helped increase his knowledge and expertise - even if it has been rather a baptism of fire!
The market slump at the beginning of last year and the remarkable bounce-back in the wake of victory over Saddam Hussein in Iraq have certainly given him exposure to the highs and lows of investment life.
The first three months, he recalls, were spent claiming "full ownership" of the fund, which entailed a hectic round of meetings and hours analysing the data to establish exactly which stocks he wanted to keep. In the end only 20% survived.
As market conditions have changed, however, so have the opportunities which have presented themselves to Shah. The early months of 2003 saw him moving further down the market cap scale - a situation which has since reversed.
"When I started managing the fund there were a lot of opportunities among the mid-caps but they have done extremely well over the last 18 months," he explains. "This means I have been moving the fund towards the large-cap stocks."
In recent weeks, Shah has also been positioning the fund to benefit from rising yields and interest rates, with overweight positions in oil, real estate and life assurance. Banks, telecoms and pharmaceuticals are all underweight.
"The large overweight bet in oils has been a function of my view that the oil price will stay higher for longer than people expect," explains Shah. "I went through the sector with analysts back in the fourth quarter last year and it became very obvious that there was going to be an issue with supply."
A recent trip to see Cairn Energy in India has reinforced this view. "The stock has been quite a large contributor to the fund over the last 12 months, so we wanted to see their fields as well as meeting representatives from the Indian oil ministry," says Shah.
"As a result of the visit I made it a top ten position."
The principal reasons for this decision, explains Shah, were Cairn's focus on India - which he believes is a much better strategy than having diverse assets - the company's very good franchise and its knowledge of the political climate. Cairn may, eventually, become a strategic asset for a bigger player.
So how does Shah see the future? Well, he certainly has not got any plans to alter the way he manages the fund. The combination of analysing those five key areas and a devotion to absolute returns, he believes, is the best way to meet client expectations.
"My aim is to build up a long-term franchise and I am very content to grow it organically," he says.
"The market will always throw up opportunities so I need to make sure I stay fresh and flexible enough to spot them."
