Paul O'Connor:

Welcome to the Netwealth Portfolio Construction Podcast. I'm Paul O'Connor and my role at Netwealth is as head of investments. This includes responsibility for the funds available on our investment menus and the products we issue as a responsible entity, mainly being the GSS funds and managed accounts.

Joining us on today's podcast is Dmitry Solomakhin from Fidelity International Limited. Dmitry is the portfolio and manager of the Fidelity Global Long Short Fund, which is a fairly unique strategy as it employs a value bias contrarian style that essentially results in an unconstrained, high conviction portfolio of all cap global equities. Whilst there are many long short global equity strategies available to investors, the high conviction contrarian style employed by Dmitry and the team differentiates the strategy from peers in my opinion.

Fidelity International is a specialist provider of investment and retirement savings solutions. Established in 1969 as the international arm of Fidelity Investments, founded in Boston in 1946, Fidelity International became independent of the U.S. parent organization in 1980 and today remains independent and privately owned. Fidelity has offices in 25 countries around the world and manages over 893 billion U.S. dollars for over 2.8 million investors as at the end of 2024.

The investment team comprises over 400 investment professionals located around the globe who work on strategies covering multi-asset equities, fixed interest in real estate. Whilst being privately owned, Fidelity is a majority owned company by management and investment professionals with the balance being held by members of the founding family. Management and investment professionals, equity holdings are viewed positively in my opinion as this provides a strong alignment with investors.

Dmitry joined Fidelity in January 2006 as a European research equity analyst covering aerospace and defense sectors as well as airlines and logistics. During his tenure, Dmitry's developed a strong stock picking track record as an analyst and was voted top buy-side aerospace and defense analyst in the 2007 Thomson Extel Survey. In January 2008, he was appointed assistant portfolio manager within the Global Equities Team with a particular focus on technology, industrial, soft commodities, shipping, and petrochemicals. And from November 2008 till September 2013, was portfolio manager of the Fidelity Funds Global Technology. Dmitry has a Master of Science in Honors in Applied Mathematics and Computer Sciences from Moscow State University and also holds an MBA from INSEAD.

The Netwealth Super and IDPS Investment menus currently have 11 Fidelity funds covering global equities, large, small cap and emerging markets, Australian equities being large mid and small cap funds, India, China and Asian equity funds, and of course the global long short fund Dmitry manages.

Over the last decade or so, we've seen a changing market dynamic in terms of portfolio construction and it's something that we certainly say regularly at Netwealth through our managed accounts. What I mean by this is that many investors have replaced lower tracking error active funds in their portfolios with lower cost passive strategies, which they then blend with higher tracking error, more concentrated active strategies such as the Fidelity Global Long Short Fund.

This theory known really as core satellite in terms of portfolio construction is that investors are using passive strategies for exposure to markets they consider are more efficient and hence more difficult for active management to outperform. And then the more concentrated active strategies in markets considered less efficient in terms of trying to get some alpha then into the portfolio. And also I guess in terms of considering concentrated strategies that use shorting also as when a strategy includes shorting, it actually widens the investment opportunity set for a manager to be able to generate positive returns from shares all markets falling in value.

In recent years, we've seen global equity returns increasingly being driven by smaller number of the U.S. mega cap tech stocks. And I guess in the Australian equities market, we've seen returns really driven by the top major Australian banks. So I'll be interested in Dmitry's views as to whether this sort of concentration in terms of the number of stocks driving equity market returns has created more opportunities for an equity strategy or if it's more difficult to be able to generate offering that environment.

Obviously, the market turmoil we've experienced over the last few weeks as a result of the Trump administration's rollout of tariffs has resulted in a significant market sell-off and spike in volatility. So again, I'll be interested to discuss with Dmitry whether the impact of these actions and market repricing has created more opportunity to generate alpha looking forward over the short to medium term from both long and short positions or a combination of both.

So maybe Dmitry, to begin our conversation, can you share with the listeners your journey, career journey in financial services and how you came to your current position as a Fidelity portfolio manager?

Dmitry Solomakhin:

Hi, Paul. Thanks Paul for having me, and thank you very much for the introduction. In terms of my career progression, as you mentioned, I joined Fidelity approximately 20 years ago as an analyst out of the business school, and for me it was a career switch, to be honest.

Prior to joining Fidelity, I was in different industry. I was an IT consultant implementing SAP systems for consumer goods companies and then decided to change my career. To be honest, Fidelity was a bit of an accident. I never thought of myself actually working in investment industry, but they came on campus at INSEAD at the business school and I went to the interview and really liked the people there. That's how the whole thing started and I'm still here.

Paul O'Connor:

Yeah, very interesting there. And then you've obviously lived in various parts of Europe. I'm assuming then obviously in Russia and now in the UK there. An interesting career journey for you I guess, moving from IT consulting and it probably would've grounded you quite well in a good solid understanding of the IT industry as well in terms of understanding the stocks and the opportunities that you have now as a portfolio manager.

Dmitry Solomakhin:

This background definitely helps, especially when I look at the recent trends. For example, artificial intelligence. I can definitely relate to some of this, you know, my previous expertise.

Paul O'Connor:

We've seen markets turbocharged by the results of the U.S. election. However, market sentiment has shifted recently with heightened concerns on global growth slowing and higher inflation, and obviously now potential of a global trade war courtesy of the U.S. tariffs. Dmitry, can you share with us your current observations on the market and the investing environment?

Dmitry Solomakhin:

Yes, maybe I'll just give you a few more things just by the way of background because it's important to put things into the context of what I do just in terms of the investment process because I try to be as bottom as possible and as stock-specific as possible.

Effectively, what I do the in day out is I look at single names in this particular contrarian value bucket. I call my loan book a book of blow-up. It's basically a set of companies where the market believes the business models are broken. And as a result of that, I have to pay my attention to the outside environment. I can't just ignore it. But for me, by and large, it's all about single stocks or specific things. In terms of these big political macro events, geopolitical events, these things tend to happen every few years. I'm thinking now throughout my career, obviously the global financial crisis back in 2007, '08, '09, that's when I started tracking money.

I took over my first fund. It was, I remember to this date, November 20th, '08, roughly two months after Lehman Brothers went bankrupt. That was interesting timing. Then obviously we lived through the Euro crisis, Eurozone crisis. Then we had the first Trump presidential election, which came as a big surprise. You might remember 2016. Then we had the COVID crisis and we had the China crisis. Now, we have the second Trump administration.

So this thing happened in Western every time, but what I tend to do each time, I just go back to the basics, back to my investment process and tend to go through the portfolio stock by stock. There are opportunities in all these events, but you just have to be a little bit careful and always all refer back to the process, if that makes sense.

Paul O'Connor:

Absolutely there. So I guess what I take from your comments there that you are purely a bottom-up portfolio manager, and I guess it makes sense to me that you are not trying to predict any outcomes of what someone as unpredictable as Trump would be doing or the impact on market, nor trying to make any great macro call over the global economy. So just focusing on those stocks.

You mentioned that you focus on stocks that blow up. How do you get a focus on the stocks that you research to consider shorting, which I'm assuming would be stocks that haven't blown up but they've got overvalued?

Dmitry Solomakhin:

Yeah, so shorting is a mix of things. I would say in a normal market environment where there are no major themes, no major market excesses, it's a good idea to also short such broken businesses where they're really broken. Broken balance sheets, but corporate governance, maybe fraudulent accounting. That's all been part of my process, part of my short book and here I'm being helped by three Fidelity analysts who are dedicated just to shorting.

Having said that, if I look at the markets over the last few years, we have got certain market excesses in various areas and then this provides very good hunting ground for my shorting process. For example, if I go back to COVID times, back then there were a number of COVID winners that were completely overvalued, sort of digital economy winners, but their business models were quite fragile. That was very good idea to go take a look for potential short names.

Then we had this ESG-driven. How would call it? Market bubble. And I have absolutely nothing against ESG. Some companies are very good businesses. But with this trend, you had some businesses that were kind of almost fraudulent with very poor business models that proved very good shorting ground again. Now, most of my short book is an artificial intelligence related names.

Paul O'Connor:

Which sort of makes sense. Again, the feeling that there's a bit of a bubble obviously in AI, but we'll get into AI a little bit later in the discussion today, Dmitry.

Have recent falls in share prices broadened your opportunity set from a value perspective or is it really too early to make any assessment until you gain some comfort on company earnings?

Dmitry Solomakhin:

When share prices fall, it always provides you with potential opportunity, but in these situations, my starting point is always my existing portfolio because for every stock that I have, I have certain target price or price range in mind. And if the share price has fallen, but I think that the valuation case is still valid, the opportunity has just become more attractive for the stock that I already owned. So this is always my first priority and that's what I've been focusing on, to be honest with you, over the last few weeks.

Paul O'Connor:

Long-short equity strategies available in Australia, typically only short markets rather than individual stocks, but I know your fund and as you mentioned we are talking about shorting individual stocks. Is this what really makes your strategy different to most peers?

Dmitry Solomakhin:

Well, I think the key differentiating point is actually the investment style, which is contrarian value. That's very unusual. On shorting, I think clients would not like to pay me for shorting the markets because you can do it through other means. You don't need a fund manager do it for you. But what I try to do, I try to leverage Fidelity platform, including the shorting team to come up with single stock short ideas. And if I look at my track records, in exception of the product, shorting has actually contributed quite positively to the overall fund returns.

Paul O'Connor:

And I assume through the history of your fund, you've always had a reasonable number of shorts in the portfolio or can it vary significantly your portfolio's exposure to individual short positions?

Dmitry Solomakhin:

The number of shorts over time has been quite stable. The way around the portfolio, it's a 130-30 construct. So 130 loan and up to 30% short. And I've tried to keep it at these limits pretty much, very close to 30%. My short book, I would typically run between 20 and 30 short positions, individual short positions.

Paul O'Connor:

So why contrarian investing and I guess how did you decide that this philosophy best reflected your approach to investing?

Dmitry Solomakhin:

I think in the market you don't decide what you do, the market decides it for you. Typically, what happens, you try a lot of different things and most of them don't work for you and then you end up with something that tends to work at least from time to time. That's how it ended up for me.

I tried investing in normal quality stocks, growth stocks. It was not particularly successful and contrarian is a niche, which I think is quite good because there is a lot of opportunity, big market dislocations because people are very, very uncomfortable. And I actually think it's a safer way to invest because at any given point in time, emotions are running high. Most investors are not interested in the stocks that I look at. And you want to have a situation where for your positions you have more potential incremental buyers, not incremental sellers, albeit it's quite uncomfortable holding these names.

Paul O'Connor:

Am I correct then in thinking that your contrarian investing is very similar to deep value investing?

Dmitry Solomakhin:

It's valued hard, but there is a subtle slight difference. So contrarian investing is similar to deep value, but it takes it to the next level. For a traditional value factor, we typically have some kind of a screening tool which would look at the current valuation, maybe past valuation and take a view that certain stock is cheap. That's why it's deep value.

In my case, some of the companies may not look cheap at all because the business models have been disrupted. Maybe they don't generate cash, maybe there are no real earnings. So it's a turnaround more than deep value. And for every company that I own, I construct a potential turnaround scenario. I do my own numbers with help of Fidelity Research. I do my own valuation, which is drastically different from the market. And then if I'm right, the stock can appreciate a lot and the market will look at the company in a completely different way. It becomes a normal franchise again. So that's the difference between this approach and traditional deep value.

Paul O'Connor:

In terms of risk management, I'm thinking about your portfolio that you have a concentrated holding of stocks, so you won't hold certain gig sectors I guess just to lower the tracking error in your portfolio. And obviously short positions, the potential losses can be unlimited. So how do you think about risk management and implement risk management from a portfolio construction perspective, Dmitry?

Dmitry Solomakhin:

Yes. So this fund is a high conviction concentrated fund. It's completely benchmark unaware. My performance is measured against the benchmark, but I don't really pay much attention to it whatsoever. Basically, if you look at the long-term industry data, you can see that in most cases, the benchmark over time or long time beats most of the peer group in the global diversified space, including the fees. Maybe the benchmark is ahead of approximately 85% of the peer group. So if you want to stand the chance to outperform the benchmark and not be beaten by the ETFs, you have to do something drastically different. It doesn't have to be contrarian value. It can be growth, it can be super duration quality, but it has to be something different. Otherwise, I think you don't stand the chance.

As a result of that, you do have high tracking error and very high concentration. Short term, it can create a lot of deviation from the benchmark. But over the longer term, I think this approach gives you superior results.

And then to your second point, Paul, on the short book, you're absolutely right. If you don't control the risk for shorts, you basically go bankrupt quite quickly because pain grows when you get your investment thesis of timing wrong.

There are a couple of things that I do for my short book. As I mentioned earlier, the 30% is the limit at which I can run my short book, and I typically am very close to this limit, which means that whenever things go wrong, I have to act quite quickly to bring back the exposure, back to under 30%. And the other point for any position that I take, short position that I take, I have a stop loss budget in mind, and if the position size exceeds my target size, I cut it back the way it should be from my point of view. This way I make sure that the losses are potentially controlled.

Paul O'Connor:

2024 was a very strong year for equity markets and obviously a bit more of a challenging time for your strategy. How do you manage the fund through these types of periods, including the number of long and short positions in the portfolio?

Dmitry Solomakhin:

I typically stay very consistent in my process. It hasn't changed at all whatsoever. It's roughly same number of holdings, same position size. It's basically day by day and stock by stock. I change very little. Obviously, last year was a tough period for the strategy because the market was driven by high growth momentum stocks. But then for example, you can go back to 2020, to the COVID times, which was another tough year for the fund. And then this reversed subsequently in '21, '22. And I remember having conversations with clients along the lines of, "Okay, what have you learned? What has changed between 2020 and '22?" For example. To which mine was typically absolutely nothing. It's still same name, same process, same idea, just the market has changed. And I think the situation in '24 was quite similar to that previous experience. So in short, nothing has changed whatsoever.

Paul O'Connor:

Yeah. Well, I guess that's probably the number one point that consultants like myself would look for in a fund that it stays absolutely true to label. But I think as you were answering the question there, it was really in my mind that investors really need to make sure that they invest for the longer term in these types of strategies. Because as you rightly point out, like all strategies, there will be occasions when the market is going against you. And for example, the amount of short positions may not be working because there's so much momentum going into the market. So it's really just the caveat there that people need to stay invested over the long term and allocate to these types of strategies and not gauge on any shorter term type performance.

Dmitry Solomakhin:

Yes, I completely agree with you.

Paul O'Connor:

Well, I guess you probably had a number of conversations trying to make sure that the clients, you hold their hand and they stick through the course of the journey and don't make irrational decisions, I guess over the shorter term.

Dmitry Solomakhin:

It is a very high conviction fund and typically people who are invested, they know exactly what they have invested into and usually the relationships they also built over the years, I've now got few clients who have invested pretty much at launch and it's very good relationship at this stage. They know exactly what I'm doing, why I'm doing, and for any new client, I'm always very upfront about the fund, what it can and cannot do, and how people should or should not use it.

Paul O'Connor:

Well, the more knowledge and education that people have about these types of strategies, I think it makes for a more comfortable journey over the long term for the investor there. Dmitry, certainly makes sense and nice to hear that you've had some investors there around for what? 12 years now or so in the funds. So you're obviously doing something right there.

The generative AI craze has been a key driver of market momentum, and we've touched on this earlier in the discussion, but can you talk us through the AI ecosystem and what concerns you most across the value chain?

Dmitry Solomakhin:

So I have absolutely no problem with AI as a theme. It's absolutely real. It's fine, though we all know there's a number of very, very useful applications of AI, be it in customer service, in code development, in a number of other industries. And these applications use cases will only grow. That is perfectly fine. But then on the other hand, if you look at the technology itself, it's nothing new at all. What we call today AI or generative AI is what used to be known as machine learning several years ago. And prior to that 15, 20 years ago, we used to call it stochastic optimization algorithms. I used to study actually some of the stuff back in the university, it was just called differently.

So the technology has advanced in a very meaningful way, but the underlying principles are pretty much the same. So there are certain limitations to what these things can do and cannot do. And I think we have overshot a little bit in terms of the expectations. Obviously, we see this very significant CapEx ramp across the industry. Like we've seen in the past, in many cases, people want to be first, people want to overspend, and as a result it creates a mini kind of CapEx bubble which needs to reset at some point. And I think this might happen over the next year or two as people realize that now they need to generate the returns on the investment they made and maybe the macroeconomy is not that great. So I think it's quite risky right now.

Paul O'Connor:

Maybe then, Dmitry, to finish, can you talk us through some of your higher conviction positions in your portfolio from both a long and a short perspective?

Dmitry Solomakhin:

Starting with the shorts, unfortunately, I can't disclose individual single stock names just for compliance reasons. But if you look at the portfolio position, my biggest underweight or short would be U.S. and the more specifically technology within the U.S., without giving single names.

Paul O'Connor:

Maybe a little AI related.

Dmitry Solomakhin:

Yeah, yeah, absolutely.

Paul O'Connor:

Maybe.

Dmitry Solomakhin:

It's not that difficult to figure out, but there's a theme. And on the long book, it's a portfolio of idiosyncratic ideas. If I look at my top positions, number one, today's probably Rolls-Royce. It's an aircraft engine manufacturer. It's in the UK, but it's a global business. It's been a good successful turnaround story under the new management. I've owned the stock for many years, I still hold it. And the second-largest position is Babcock. It's now the UK listed NAMESMITH cap in defence. Their main exposure is nuclear and naval vessels. It's a turnaround story again, under the new management team. The head and accounting issues, business execution issues, and now the company is improving. So these are the top two names.

Paul O'Connor:

It's interesting when I was having a look at your portfolio. I think you had very little or no exposure to the U.S. market, which is obviously quite rare for when I look at most of the international equity funds available in the Australian market. And I guess my thinking out of that is that possibly the U.S. market may be the most overvalued market of all the equity markets obviously driven by the MAG7. So I think that sort of aligns with your strategy. Would that be a fair point?

Dmitry Solomakhin:

Yes, that's absolutely fair. I mean, there is value in U.S. markets, especially in the Smith cap space, but overall the index... You know, the U.S. market is very, very extended relative to the rest of the world. It's now approximately probably 65% of the benchmark, and I'm approximately 60% underweight. I do have some exposure to the U.S., but very few select names. If you go back 10 years ago, the U.S. used to be actually quite significant overweight in the portfolio because back then I could see a lot of value in the market, but things have changed.

Paul O'Connor:

Naturally and that's equity markets there and it's probably remiss of me given all that's going on in the markets, but have you got any thoughts or comments on the current volatility going on in markets and obviously the craziness of the Trump administration and the global trade war that they seem to be picking at the moment, although they have recanted over the last day or so a little?

Dmitry Solomakhin:

I've always had the view that in situations like that, when you don't quite know what is going on and things are changing very rapidly, sometimes the best thing to do for a bottom-up fund manager is to do nothing. And that's just quite difficult to do because you're urged to do something, but sometimes doing nothing is the best.

Obviously, I go through the headlines, I look at the market moves, but I make very little incremental changes to the portfolio because there's one headline now, but two hours later, there'll be something completely different as we've seen a couple of times this week alone. So it's quite difficult to follow and maybe it's actually dangerous to follow as well. So that's the approach.

And then on the broader subject of volatility poll, most of my peers would view volatility as an enemy, but actually think it's your friend if you manage it wisely, if you are a patient because volatility creates opportunities.

Paul O'Connor:

Very true. And I must admit, I have thought that whether the Trump administration has been a catalyst for some of the repricing of equity markets and some of the excessive valuations that have been applied to companies such as some of the Silicon Valley companies we may have been referring to earlier in terms of AI there, Dmitry.

Dmitry Solomakhin:

Yeah. Absolutely.

Paul O'Connor:

So Dmitry, thank you very much for the time and your thoughts on the Netwealth Portfolio Construction Podcast. It's been really interesting delving into the mindset of a manager who I guess sounds like you are purely focused on alpha, which is sort of quite refreshing, again, given a lot of the equity strategies that we see in the Australian marketplace, but predominantly the returns are made up of beta. So it's been very interesting hearing about your concentrated positions, how you think about shorting in a portfolio. And I guess your last comment there around volatility is your friend, and really that's what investing in risk markets is about. Risk is volatility at the end of the day, so having the opportunity there to spend this time with you, I thank you and for the time and your insights into the podcast today, Dmitry.

Dmitry Solomakhin:

Thank you, Paul. Thanks for your questions and thank you very much for having me.

Paul O'Connor:

To the listener, thank you again for joining us on another instalment of the Netwealth Portfolio Construction Podcast. I hope you've enjoyed the discussion with Dmitry as much as I have had today, and I look forward to you joining us on the next instalment of our podcast series. Thank you all.