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With actively managed equity funds showing outflows for most of the past two years, according to research company Morningstar, even the most orthodox strategies are a tough sell.
The few funds still gaining traction with investors have tended to focus on sub-sections of the market, such as technology or sustainability.
That has hit demand for “special situations” funds, a loosely-defined term that often refers to funds that see opportunities in one-off events such as restructurings or mergers and acquisitions, and whose investment philosophy emphasises manager skill above theme or factor.
Such is the scarcity of special situations funds that, among the thousands of active funds available to UK clients, only 26 currently carry the moniker, according to Morningstar.
The funds began as a way for investors to profit from corporate activity such as M&A, but while this is still popular among institutional investors, retail clients tend to be deterred by the lack of daily liquidity, according to Richard Swain, head of funds research at Bentley Reid, a wealth manager.
“For retail clients, special situations funds have tended to be deep value funds,” says Swain, referring to the strategy of investing in stocks whose market value is judged to be far below the asset value of the issuing company. “At a time when allocations to value strategies [and] to UK equities have been falling, it is perhaps inevitable that demand for these funds has dimmed.”
Some investors are put off by their institutional-style approach, which tolerates less liquidity while giving the fund manager greater flexibility.
“We tend to avoid them due mainly to the fact that you are never quite sure what’s in them,” says Simon King, chief investment officer at wealth manager Vermeer Partners. “The name is a bit of a catch-all and there’s a wide diversity of strategies within them, including many that have no strategy at all.” Because returns are often inconsistent and correlated with small and mid-cap share prices, it is better simply to hold funds aimed at these, he added.
“Many of the ‘star’ managers in the sector are ‘gunslingers’ and shift portfolios around a lot. If they are really good they tend to gravitate to running hedge funds.”
Ben Yearsley, co-founder of consultancy Fairview Investing, does use special situations funds in portfolios, but agreed the vagueness of the term deters many investment managers.
“It’s fair to ask, what is a special situations fund? Is it a value fund? A go-anywhere fund? Multi-cap? Even growth? The lack of an answer probably explains why the name is declining and I can’t think of any new launch in years,” he says.
“Because there’s no definition of what a special situations fund is, there’s no defined portfolio place. Most [managers] construct portfolios with each fund having a specific place. Therefore, if you don’t know what the fund will invest in, how can you buy [it] in a portfolio?”
Advocates, however, can counter by pointing to the performance of some funds. Investment manager Ninety One’s UK Special Situations fund, for example, which launched in 1978, currently ranks fifth among the more than 200 funds on the Investment Association’s “UK All Companies” league table for its returns over the past five years.
Alessandro Dicorrado, who has run the 46-year-old fund for the past four years, described special situations funds as “a more flexible rendition of the value approach”.
“Traditional value [investing] can be very systematic and rigid,” he says. “Special situations tends to be a bit more open-minded. It is about finding companies that are mispriced, but whereas value strategies and some of the institutional funds tend to focus on identifying a particular catalyst, we don’t believe it’s possible to do that — we focus on companies that are performing well and have good management.”
For Stuart Widdowson, managing partner of Odyssean Capital, the key is to find stocks that are underappreciated. “Typically, it’s a company that’s not fulfilling its current potential,” he says.
One indicator is a change of chairman in the past three years. “Such stocks are often underappreciated because investors who focus on momentum are looking for companies that are perfect, or almost perfect, so they wouldn’t be looking for special situations,” says Widdowson. He also checks out a company’s top 10 shareholders to see if “they are aligned with our thinking”.
He warned, however, that “special situations take a lot of work to identify and to work on. So, for example, if you run a 100-stock portfolio as some managers do, you wouldn’t be able to spend the time required.”