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Investment fad has led to an identity crisis
Thursday 02 Feb 2017 Author: Steven Frazer

Special situation investment strategies are either considered to be the ultimate in active fund management or vanity projects for show-off stock pickers.

They were all the rage about a decade ago after an 18 year run of super performance by Fidelity Special Situations Fund (GB00B88V3X40), then headed by star investor Anthony Bolton.

That led to something of an investment fad in the sub-sector, with many fund management firms rebadging themselves as special situations mavericks. Cynics claim such moves were little more than a marketing ploy.

What began as a remit for investing in recovery or turnaround stories, buying potential takeover targets or possible demerger situations, has ultimately broadened and became more nebulous.

Are these funds really that different to mainstream ones? 

A few special situations funds say their objective is to find unrecognised growth potential. That’s really just a broad brush stroke description of investing in general.

Artemis UK Special Situations Fund (GB00BB36JR17), for example, say it looks for ‘unrecognised growth potential in companies, often those that are unloved or out-of-favour’.

Managers Derek Stuart and Andy Gray see ‘problem investments’ as a rich seam of opportunity because of the inherent potential for substantial returns if a struggling company successfully pulls-off a turnaround.

Fidelity fund manager Alex Wright looks for ‘unloved companies entering a period of positive change that the market has not yet recognised’.

That echoes the Artemis point that ‘if things unexpectedly improve, there is significant upside as the consensus view changes and new investors buy into the story’. One could also suggest the downside could be limited if the story is out of favour in the first place.

Alastair Mundy, who runs the Investec UK Special Situations Fund (GB00B1XFJS91), eschews the apparent identity crisis some associate with the space. ‘I’m not sure they are supposed to be anything,’ he says, adding that it doesn’t really matter.

Funds table

Attractive performance statistics

While it is easy to be critical of what the name ‘special situations’ has become, its appeal is obvious when you look at the performance statistics.

As the accompanying table shows, you could have made at least 10% annualised returns over the last decade plus 30%+ last year with certain products.

Waiting for big sell-off before buying

Mundy hunts for stocks which have fallen at least 50% from their highest point. He’s looking for situations where investors have ‘given up hope’ and expectations are largely for the company to fade away.

It’s at that point that he mobilises his research team to conduct ‘a lot of fundamental analysis.’

Can the conventional wisdom be challenged? If yes, he might invest. It’s a risky strategy that Mundy freely admits often doesn’t pay off. When it does, the returns can be more capable of offsetting the misses.

Perhaps the key to understanding this sub-sector is demonstration rather than explanation, namely looking at the stocks being added to portfolio.

There is certainly some common ground among the Special Situations managers. Most seem to massively favour domestic UK shares and oil stocks, largely shunning overseas opportunities unless foreign markets are a fundamental part of their strategy.

There also tends to be a natural bias in favour of mid and small cap stocks, although this is not true across the board.

A Blue Morpho Butterfly at the Niagara Parks Butterfly Conservatory. Shot taken with a Canon 40D/100mm lense.

Banks are popular among special situation fund managers

Fidelity’s Alex Wright’s believes that banks still look cheap on a historical basis, with valuations on some hitting financial crisis lows following last summer’s EU referendum despite ‘improved balance sheets, cleaner loan books and a healthier earnings.’

Wright holds banks on the basis that market valuations have yet to catch up with earnings, while rising interest rates would add support as this tends to prop-up net interest margins. This has played out fairly well recently, his holding in Citigroup (C:NYSE) saw its shares run up strongly ahead of December’s US Federal Reserve rate increase.

Construction and the oil industry are other areas popular now with Wright, with CRH (CRH) flagged as a possible play on Donald’s Trump’s Mexican wall, while Royal Dutch Shell (RDSB) is his fund’s biggest single stake.

Investec’s Mundy has his eyes trained currently on the UK high street and consumers, areas yet to feel any meaningful pinch from rising wages and cost inflation judging by October to December Office of National Statistics consumer spending data.

But the situation might be very different in a year’s time. Retailers may be dealing with the fallout of lower footfall and not as much cash going through the tills. Mundy’s keeping a watching brief.

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