Fidelity Global Special Situations

Tom Whitelaw, Analyst at Morningstar: Despite Fidelity Global Special Situations' poor recent performance, we believe it holds promise for the right investor.

Over the three months through 12 Nov. the fund has lost 31.7%, 14.4% more than the Morningstar Global Large-Cap Blend category average. Ill-timed forays into select financials have hurt. In March, manager Jorma Korhonen’s financials exposure stood at 10%, but new purchases of Wachovia and Morgan Stanley and a top-up of Lehman Brothers helped push the financials weight towards 17% by autumn. This wiped out the positive gains he had made since early 2007--a year in which the fund strongly outran its Morningstar peers.

That said, we believe there is reason to look beyond the large short-term loss. First, Korhonen's process is in keeping with the fund's successful heritage before it was split off from Fidelity Special Situations. Like Anthony Bolton before him, Korhonen looks for companies that he believes show unrecognised value. To identify opportunities and avoid value traps, he pours over the analysis produced by Fidelity’s analyst staff to determine, for example, an industrys supply and demand drivers. He also takes great care in formulating his view on a company's value before jumping in--he conducts in-depth scenario analysis on prospective stocks by looking at the assumptions made in a company’s current share price. He will then model best and worse case scenarios to build up a risk reward picture to determine the level of investment with which he is comfortable.

We also derive comfort from the fact that Korhonen is an experienced analyst, and has had success managing single country funds and global portfolios (albeit over relatively short periods) in the past. Our own conversation with him left us impressed with his rigour, and as a global manager, he is backstopped by an analyst staff whose breadth and depth we believe is among the best in the industry. Korhonen has also acknowledged the lessons he has learnt. He is not making major changes to his strategy (it would concerns us if he was) but he is reducing stock-specific risk in current markets by spreading his holdings more widely.

Despite that nod to moderation, the fund is not for everyone. Korhonen’s main concern is with absolute returns. As such he pays little attention to the index. This approach, combined with his contrarian tendencies, means that at times the fund will differ markedly from its peers in the Morningstar Global Large-Cap Blend category, both in terms of portfolio positions and performance.

We're not happy with the recent losses here, but we can see how Korhonen's process led him into these names, and we think the conviction he shows in his process and picks is essential for a special situations manager. It is still early days for the new manager and investors should expect short-term volatility and periods of underperformance from a fund which clearly sits at the upper end of the risk spectrum. However, over the long term we believe that Korhonen, backed by Fidelity's research, has the ability to outperform.

Strategy

Like his predecessor Korhonen seeks companies with unrecognised value. He looks at the assumptions in a company’s share price and considers if these are correct. To do this effectively he has to have an excellent understanding of the industries in which stocks operate. As such he spends around 50% of his time reading the analysis produced by Fidelity’s research team. He also has access to the group’s quantitative team, but uses it on an ad-hoc basis only as he dislikes forecasting. He prefers to model how companies will perform in different scenarios through an in-depth understanding of the supply and demand dynamics of their industry. He then looks at best and worst case scenarios to assess both maximum upside and downside, accepting that he will be wrong around 35% of the time. This process helps formulate the manager’s risk reward assumptions which in turn will determine the level of investment with which he is comfortable.

Korhonen uses the fund's UCITS III powers to run short positions. He prefers to do this via single-stock shorts, but in period of extreme market movements, may buy protection via index puts. The process for selecting which stocks to short is the exact opposite of his long process: he looks for stocks whose fundamentals don't appear capable of supporting their valuations.

Management

Jorma Korhonen has been in sole charge of Fidelity Global Special Situations since January 2007. He worked alongside Anthony Bolton from September 2006 to smooth the transition of the fund when it was created by the split of Fidelity Special Situations. Korhonen joined Fidelity in 1996 as a research analyst working in both London and Boston where he covered, amongst others, the financial services and banking sectors. In 2002 Korhonen was appointed manager of Fidelity’s Iberia, Italy and Switzerland funds. Two years later Korhonen moved across to run global portfolios with responsibilities for Fidelity Global Equity (for Japanese investors) and Global Focus (for Australian investors).

Korhonen manages the fund singlehandedly but relies on Fidelity’s well-resourced global analyst staff who publish around 160 stock reports daily. Some ideas also come from sell-side research and the manager’s conversations with industry contacts. However, 70-80% of ideas come from Fidelity’s internal research team even if Korhonen gets an idea from an external source it will be run past his trusted analysts first. Korhonen speaks to at least one UK analyst daily but also visits Boston, Tokyo and Hong Kong regularly to meet analysts and companies in person.