Why you should hold a special situations fund

Do you fancy investing in unloved stocks? By this we mean companies that have disappointed analysts, been through a crisis, or are just generally overlooked. On the face of it, this approach doesn’t seem very appealing. Why would anyone want to spend their hard-earned money buying shares in potentially troubled firms?

However, the reality is many of these names are exceptional businesses whose share prices have the potential to soar over the longer term. This is why many fund management groups run portfolios aiming to hunt out and invest in stocks that are either being shunned or dealing with challenges.

Why are they worth considering?

Investing in stocks (equities) is rarely straightforward. The share prices of companies fluctuate on a daily basis due to a wide variety of reasons. Sometimes they will rise – or fall – in response to the release of quarterly financial results or the announcement of a new product launch. Other times the volatility endured may be nothing to do with the company itself, but rather a change in investor sentiment towards the sector in which it operates.

The idea of a special situations fund is to find these under-appreciated (and, therefore, undervalued) stocks, buy them at depressed valuations and then watch the share prices rise. However, there are obviously potential downsides. There’s no guarantee that the market will ever recognise the company’s potential.

How to choose a fund

The good news is there’s no shortage of special situations portfolios available, so the difficult part will be choosing the right one to meet your needs. The ideal fund manager will be someone with a strong track record of outperforming in various economic environments. Strong research capabilities within the investment house itself will also be advantageous, including access to analysts covering various sectors and markets. As many companies fitting the special situations description will be smaller, expertise investing in this area of the market will also be required.

Liontrust Special Situations

The aim of this fund, which is run by a team of four managers, is to deliver long-term capital growth by investing in companies with durable competitive advantages. We would describe it as a best ideas portfolio as it can embrace UK companies of any size, although it favours smaller and medium-sized businesses.

One of the most interesting aspects of this fund is its so-called ‘economic advantage’ investment process that focuses on finding businesses with hard-to-replicate intangible assets. These include intellectual property, a strong distribution network, recurring revenues, and barriers to entry that protect its competitive position. We believe this fund is definitely worth considering by any investors wanting a high-conviction, multi-cap exposure to the UK stock market.

Fidelity China Special Situations

As we mentioned above, the special situations approach isn’t confined to the UK. As its name suggests, this investment trust searches for companies meeting this description in China. Dale Nicholls, who has run the portfolio for a decade, predominantly invests in companies listed both domestically in China and on the Hong Kong Stock Exchange. He can also include Chinese companies that are listed on other exchanges around the world, as well as those with significant interests in the country.

Cash-generative businesses with good long-term prospects that are underestimated – and undervalued – by the market will be favoured. However, there is a caveat. Its bias towards smaller and medium-sized companies in a developing market means it’s not for the faint-hearted, so investors need to accept it will be a volatile ride.

IFSL Marlborough European Special Situations

Fund manager David Walton, who has been at the helm for more than a decade, scours international stock markets for under-the-radar opportunities. While he invests in European businesses of all sizes, the portfolio is more focused on smaller and medium-sized names that are often overlooked by analysts. As a result, it will be full of companies that may not be instantly recognisable, such as Proact* IT, a Swedish data and information business.

Undervalued stocks with above-average growth potential and strong management teams that are incentivised to perform will be particularly favoured. We consider the team behind this fund to be experts in their field, with a track record of successfully mitigating the risks associated with smaller firms.

*Source: fund factsheet, July 2024