Fidelity Future Leaders Fund: Themes, Lessons and Thank You the Strong Bounce in the Australian Equity Market in Headwinds for the Economy

From the desk of James Abela March 2019

Fidelity Future Leaders Fund: Themes, lessons and thank you The strong bounce in the Australian equity market in headwinds for the economy. The Reserve Bank is becoming February was broadly interpreted as unsustainable more cautious as global growth slows and a rate cut due to lower earnings expectations and weaker looks imminent. outlooks. However, a number of companies reported For investors this will mean a greater focus on balance a more confident outlook and as a result energy, sheets as sustainability moves to front of mind. High risk/ metals, financials, technology, healthcare and low quality businesses which have experienced phenomenal industrials all performed better than expected. support in the search for yield over the last few years will Results season delivered some big positive price moves see this wane as liquidity slows and risk tolerance declines. from those quality growth stocks or cyclicals that delivered Some critical lessons from history form the foundations strong results. Altium, Appen, A2 Milk, Bluescope Steel, of my portfolio construction process: Cleanaway and Breville were notable winners. On the flipside there were some big negative price moves from 1. The Fund’s Quality, Momentum, Transition and Value those that disappointed such as Blackmores, Bingo, Pact (QMTV) framework is a balanced approach that can and Eclipx, proving that markets are still challenging deliver alpha throughout the cycle and is key from a companies that are exposed to cyclical softness or portfolio risk management perspective. competitive market structures. 2. Remember 2007 – high leverage is not an everlasting Some fundamental themes that emerged from the provider of growth. latest report season include: 3. Remember 2000 – valuations and risks are cyclical. ■■ Costs – generally rising at a pace faster than could And now being distorted by low discount rates, low be recovered given rising competition in most markets, risk premiums, low inflation, low costs of capital, liquid as revenues remain a challenge from those not capital markets and low volatility. experiencing structural growth or cyclical upswings 4. Returns on capital, earnings and cash flows ultimately ■■ Capex – is still at relatively low levels, with companies drive valuations – Viability, Sustainability and Credibility favouring buybacks or M&A (VSC) are the long-term ‘pillars of success’. The popular quote ‘Revenue is vanity. Profit is sanity. ■■ Capital management – featured with numerous buybacks (Bluescope Steel and CSR) Cash is reality’ is perhaps more relevant today than ever. Companies need to really drill down on fundamentals such ■■ Second half club – many management teams are as profit and cashflow rather than ‘top line’ revenue witnessing softness and expressed caution while expecting a recovery in the second half of 2019. For investors in the Fidelity Future Leaders Fund, my strategy in the current market is to maintain a strategic tilt toward Moving into the second quarter, previous strong performers growth at a reasonable price and value. Later in 2019, such as the Australian housing market, non-residential scarcity premiums will likely see a move towards growth construction and some retail sectors are likely to cause and sustainable yield.

Winner of the Morningstar 2018 and 2019 Fund Manager of the Year, Domestic Equities Small Cap Category, Australia* Conviction is driven by a high valuation discipline across the portfolio. I believe in holding companies with sustainable value yield, defensive positioning and sustainable quality. Concerns around the global slowdown have translated to a resolute move away from high risk momentum or companies that rely on equity or debt liquidity. Finally, I’d like to take the opportunity to thank you all for your support over the past couple of years. I feel very fortunate to have picked up the Morningstar 2019 Australian Fund Manager of the Year – Domestic Equities Small Cap Category for a consecutive year.* Sincere thanks go to my clients, the Fidelity family and the rigorous client-centric risk–return framework of Morningstar.

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