What next for Bolton and his disciples?

Jorma Korhonen, manager of Fidelity Global Special Situations, is anxious to stress that his views on China are personal rather than the Fidelity party line.

His anxiety is understandable: he thinks the current hype about the country is "one of the biggest capital allocation mistakes ever."
That is in stark contrast to the views of Anthony Bolton, Fidelity International's president of investments and the doyenne of the investment world with an unrivalled 28-year record of making money for investors.

Bolton has decided to postpone plans for his retirement in order to launch a China fund to make the most of "the investment opportunity of the next decade" as he sees it.

In late 2009, he said: "After spending the last few months in Asia, I have become increasingly excited by the prospect of managing a portfolio investing in the tremendous growth potential of China."

The divergence of his views from those of Korhonen is startling enough. But the latter's outspokenness is all the more surprising given that Korhonen was one of the two Fidelity managers chosen to succeed Bolton as stewards of his hugely successful Special Situations fund.

So far, Korhonen has failed to live up to the record of his predecessor.

The fund, which celebrated its 30th anniversary in December, is one of the most successful retail products ever.

A £1,000 investment in the fund 30 years ago would now be worth almost £150,000, assuming dividends had been reinvested, a return almost five times better than the stockmarket as a whole would have delivered over the same period.

Most of that performance is down to the skills of Bolton, who ran the fund for 28 of those 30 years.

Split decision

Finding a manager to follow that was such a headache that the firm decided it needed two managers.

Korhonen took on the half of the fund that was converted to Global Special Situations in January 2007 three months after the split.

Its performance since then has been distinctly lacklustre. Between October 2007 and February 2009, the fund lost 45% and, while he has had a much better time since, over his three-year tenure the fund is still down 10%, putting it 96th out of 125 retail oriented funds in the global growth sector.

That contrasts with the other half, which retained the UK Special Situations name and the same strategy of seeking out undervalued or out-of-favour stocks to achieve long-term capital growth, and which was taken over by Sanjeev Shah in January 2008.

While his fund has lost 4% over the period, that is a much better performance than the market as a whole and it puts him firmly in the top quartile of his peer group.

Perhaps, unsurprisingly, it is hard to find a financial adviser with much enthusiasm for Korhonen, while Shah, despite his relatively short tenure, is already gaining plaudits.

Brian Dennehy, managing director of Dennehy Weller, says: "Fidelity got it at least half right and put the right man into the UK fund."
Mark Dampier, head of research at Hargreaves Lansdown, was critical of the decision to create a global fund three years ago and has not been won over since.

While it was Bolton's idea to create a global fund, Dampier thinks Fidelity should have gone the whole hog and made it an emerging market fund, as that is where Bolton now thinks the growth will come from.

The unpopularity of the global fund is reflected in its shrinking size. Justin Modray, who runs the www.candidmoney.com financial website, points out that the value of the global fund has fallen from £3 billion, when the split took place, to £1.7 billion now.

Allowing for the decline in the market over that period, he estimates there has been an outflow of between £1.1 billion and £1.3 billion.

Shah's fund has also shrunk, from £3.2 billion to £2.7 billion, since he took it over, but Modray estimates the outflow is a much smaller £300 million to £400 million.

Same wavelength

While Shah has had a creditable start in a period when fund managers have been severely tested, it will take some years before he can prove himself worthy of Bolton's crown.

Shah sounds like a manager in the Bolton mode. At a dinner to celebrate the fund's anniversary, Shah's comments about being a contrarian investor and seeking out unpopular sectors could have come from the older man. Indeed, on banks, the pair seem to be in complete agreement.

Shah started buying into banks early in 2009 when they were still stockmarket pariahs, a move that has been a key factor in the fund's good one-year record.

They remain a big bet for the fund - financials account for more than a quarter of the fund's assets - and Shah is unfazed by their poor performance at the end of 2009, as Dubai's debt defaults sparked fears of another phase in the financial crisis.

His continued support of the banks has hurt him in recent months. Tim Cockerill, head of research at financial advisory firm Rowan, points out that at the end of 2009 his fund gave up virtually all the outperformance achieved in his first two years as Royal Bank of Scotland and Lloyds Banking Group, which together account for more than 6% of the fund, fell sharply again.

"It is disappointing that he has lost that ground when he was ahead of the market," says Cockerill.

Shah admits: "It has been a bumpy ride, but I am still keen on banks. They are still under-owned by investors and disliked by sell side [investment analysts]."

He adds that the government rescues and rights issues have left their balance sheets in good shape and that, while new competitors have been coming into the market, many others, such as the Irish banks, have withdrawn.

Bolton agrees: "I believe the time to own banks is when we are coming out of a financial crisis. I have seen six crises and banks did very well coming out of them."

Shah says he talks to Bolton regularly, but does not feel under his influence. He asks for specific advice, perhaps once a quarter. "And, in the first three months [of my management], five of the top 10 holdings were changed."

He cites four key lessons from his first two years: that portfolio construction and the way bets are changed is "just as important as individual stock picking"; that it is important to be into a situation early - the size of the fund means that it can take a month to build a stake; and that the way shares are bought and sold is important.

Finally, he says: "I am starting to trust my intuition and judgement more than I did when I started."

Other current big bets include media companies (Yell, the bombed-out directory services operator accounts for around 3% of the fund), commercial property and technology.

Shah adds that he dows worry about the growing consensus in the market on the attractions of the latter.

Korhonen is also a fan of technology - the sector accounts for almost a fifth of his fund. He thinks that, as the global economy recovers, companies will increase their technology spending and will need to replenish stocks. "There is a big inventory refilling to come," he says.

He adds that "technology has been in a 10-year bear market," and, while other companies are fretting about the risk of deflation, "technology companies have lived under price deflation for decades - they are used to it."

China doubts

On China, he says, investors "have to have a view", and his is that capital is being wasted there on a massive scale. "It is being driven from the top down.

They are building infrastructure like Japan did. Can it go on for another five years? Yes it can, but not all of it is rational."

For example, he points to Ordos, a new city that has been built in Inner Mongolia with capacity for one million people, but it is completely empty. "A lot of the development is real, but some of it you have to question," he says.

Korhonen adds that the data on car sales and mileage can't be squared with demand for oil. He points out that in China's centrally controlled economy, there is pressure on local mayors to produce statistics to conform with the government's economic growth forecasts.

As is the case with other Fidelity managers, Korhonen is a stockpicker. He buys attractive companies regardless of where they are and disregards the geographical balance of the fund.

Currently almost two-thirds of the fund is in the US, compared with a third two years ago, reflecting the country's technology industry dominance.

He has virtually nothing in China, although he believes many Western companies will do a lot of business there. He has some exposure to Russia and India.

His key lesson from his first three years is that: "The world changes every day and you have to keep learning."
The collapse of Lehman Brothers at the end of 2008 was a particularly painful lesson: the ensuing six weeks wreaked havoc with the fund because of Korhonen's exposure to financial stocks.

Nevertheless, he has not changed his investment style, but says: "One thing I do now is pay more attention to the liquidity of my positions. I also spend more time thinking about the downside of my positions."

He certainly had a better year in 2009. His fund's 30% rise in 2009 put him 21st out of 158 funds. "Maybe there's some light at the end of the tunnel if markets continue to reward his current preference for financial and IT companies," says Modray.

Shorting power

Both Shah and Korhonen make more use of shorting powers (selling shares you do not own in the hope that the price will fall by the time you have to buy them) and other hedging techniques available under Ucits III regulations than Bolton did - the new powers were granted only shortly before he gave up day-to-day running of the funds.

Shah's shorts are currently around 5% of the portfolio, while Korhonen uses options partly to change the risk profile of the fund. Korhonen's shorts have been as high as 20% and as low as 7%, but are currently around 15%.

Whether these will improve the performance of the funds remains to be seen - just as the managers have still to show they can achieve Bolton's level of success.

Bolton's other funds

Anthony Bolton ran two other funds, both of which are now in the hands of others: Fidelity European, which was taken over by Tim McCarron in 2003, and the Fidelity Special Values investment trust, which Shah took on at the same time as Special Situations.

McCarron's recent record has been poor and he is to take a sabbatical from management this year. Over the past 10 years, the fund has grown by almost 140%, putting it third in the sector, but for four years of that Bolton was in charge.

Over five years, the fund slipped to 52nd from 76th. Last year, it was 91st out of 96, with a return of just 17.7%; little better than half the sector average of 30.3%. Sam Morse took over on 1 January.

McCarron was successful with the Fidelity European Values investment trust he inherited from Bolton in 2001, but this has been managed since July 2008 by Sudipto Banerji.

The Special Values investment trust is effectively a mirror of the Special Situations unit trust, except that it can use borrowings to boost returns - gearing is currently around 10%.

Over three years, it comes third in its sector with a 4.3% increase compared with a 16% fall in the sector. But over one year it has slipped to a mid-table 52.9%.

Data for these vehicles as at 1 December 2009.

Bolton on China

Although Bolton's success was as a UK fund manager, few financial advisers think that will put investors off backing him in China - indeed, it is already being marked down as likely to be one of the biggest launches of 2010, although Fidelity is considering making the fund a closed-end investment trust, which will allow them to limit the flow of funds into it.

Dennehy points out that Bolton will be able to call on Fidelity's team of analysts there. "He is not going out, Indiana Jones style, with just him and his hat," he says.
But Cockerill points out that there are not many examples of fund managers transferring their skills from one region to another - Schroders' Dennis Clough, who was one of the most admired fund managers in Asia, made no impact when he decided to run a European fund.

Bolton admits that he has concerns about corporate governance and the transparency of the information from companies and government authorities in China. But these problems are less serious for companies quoted in Hong Kong.

He adds that, in other emerging markets, periods of rapid growth started when national income reached between $5,000 and $10,000 per capita: China is just reaching that stage.

"The situation in China today is very similar to that in Taiwan or South Korea during their fast-growth phases 20 or so years ago, and in Japan before that. However, growth is occurring on an even bigger scale because of the enormous size of the Chinese population,' he says.

"Just as consumers in the West start to rebuild their savings, consumers in China are likely to start to run down their very high savings.

Many areas of the economy are in the steepest part of their development curve as consumer incomes reach a level where increasing numbers of people can aspire to own homes, cars and household goods.

"Because of the scale of what is happening and the effectiveness of a centrally run economy that other emerging markets do not enjoy, the world may never see anything quite like this again.'

This article was originally published in Money Observer - Moneywise's sister publication - in February 2010

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