Fidelity Special Situations - looking for companies with change on the horizon

• Alex Wright tries to buy shares in companies that are changing for the better
• He's got a good long-term track record
• We think there are other great UK managers whose funds are available at lower cost

Our view

Companies perform poorly for a variety of reasons. Maybe their managers made some bad decisions, or they missed an earnings target. But if they can change for the better, their share prices could recover as other investors recognise their potential.

Those are the sort of companies Alex Wright, manager of the Fidelity Special Situations Fund, tries to invest in. And we think he's done it well over the long run. Our analysis suggests he's been particularly good at investing in higher-risk small and medium-sized companies that have gone on to be successful. This fund gives him the flexibility to invest in companies of any size though.

He also uses his freedom to invest a portion of the fund overseas and can take 'short' positions using derivatives to benefit from falling share prices too. The fund's use of derivatives adds risk.

We think this fund is a reasonable choice for exposure to the UK stock market and it's got the potential to do well over the long run. But there are other excellent UK fund managers whose funds are available at lower cost. You can find our favourites on the Wealth 50.

Change is a three step process

Alex Wright aims to invest in companies going through a rough patch, but on the verge of changing for the better. He thinks they go through a three step process of change.

Step one: company is unloved

At the first stage, the company is overlooked as most investors can't see past the bad news. Wright looks for positive change on the horizon that other investors may have missed.

Pearson is in this section of the portfolio. It's struggled to adapt from a publishing business to a provider of educational materials and its earnings haven’t kept up with expectations in recent years.

Wright thinks he's spotted something others have missed though. The company's increasingly turning towards digital content, which generates higher profits than printed materials. It's also making leaps forward in its machine learning business, which grades test papers and identifies where marks have been lost.

Step two: change begins

Companies at stage two of the investment cycle start to be recognised by other investors, and the company’s share price often starts to rise.

Oil & gas companies BP and Royal Dutch Shell are examples. Their share prices were hit hard in 2015 as the oil price fell heavily and investors worried they'd cut their dividends. Since then, both companies have made cost savings, grown sales and invested money wisely. This should make it easier for them to maintain their dividends if the oil price falls in future. Alex Wright thinks these companies have plenty more growth potential.

Step three: change has occurred

When a company’s earnings and share price have recovered to the level the manager expects, he gradually sells the investment and reinvests into companies entering stage one of the cycle.

Take Alphabet (formerly Google). Wright bought shares in the company when it wasn't making as much money from its search engine being used on mobile. The shares have risen strongly since then. The manager's taken some profits and reinvested them in companies at stage one of the cycle.

Of course, not every company will recover. Some could fall further or fail altogether. The fund's success relies on Alex Wright identifying more winners than losers over the long term.

How's the fund performed?

Since he took control of the fund in January 2011, Alex Wright has delivered a return of 37.2%. That's 10% ahead of the broader UK stock market.

Returns were more subdued over the past year though. The fund fell 5.6%, while the broader UK stock market fell 3.8%*. There were some company-specific disappointments including photo booth operator Photo-Me. The company's share price fell sharply when it announced profits would fall short of expectations. Past performance isn’t a guide to the future. The fund will rise and fall in value so you could get back less than you invest.

Past performance is not a guide to the future. Source: *Lipper IM to 31/01/2018

Fidelity Special Situations Key Investor Information

More about the fund including charges