Traditionally, special situations funds are intended to hunt for unloved and undervalued stocks that are changing the shape or strategy of their business, with the funds positioning themselves to take advantage of volatility from a company to a macro level.
This contrarian style, and the returns it can deliver, has made them popular funds historically. The increasing volatility in markets in 2014 has arguably presented greater opportunities but all but two funds have lost money since the start of year, with Hargreaves Lansdown’s Mark Dampier suggesting that a slump in small and mid caps is to blame.
“They [special sits funds] will have good times and bad times, but the market has suddenly changed in the last few weeks,” he said.
“You’ve had a change from momentum shares to more defensive shares in the last two or three weeks which may have made a difference to some of the special situations funds.”
“Also, they are mainly going to be small and mid cap orientated and these stocks have had a tough time recently, particularly small caps.”
Artemis UK Special Situations, managed by FE Alpha Manager Derek Stuart, and Investec Special Situations, managed by Alastair Mundy (pictured), have beaten the FTSE All Share this year. The index has returned just 0.35 per cent since 1 January 2014 while the funds have returned 0.71 per cent and 0.52 per cent, respectively.
Performance of Funds vs sector and benchmark, since 1 January 2014
Source: FE Analytics
The other UK special situations funds – which have all lost money in 2014 - are L&G UK Special Situations, Jupiter UK Special Situations, Blackrock UK Special Situations and Old Mutual BlackRock UK Special Situations.
Performance of Funds vs sector and benchmark, since 1 January 2014
Source: FE Analytics
Blackrock UK Special Situations and Old Mutual BlackRock UK Special Situations performed the worst, falling short of the IMA UK All Companies sector average which fell 1.29 per cent, over the same period.
The rapid gains made by small and mid caps has led several managers to reduce their exposure over fears the space is overvalued and vulnerable to a market correction and the continuing challenge to find value in a crowded market.
Alistair Mundy, who runs the £1.2bn Investec UK Special Situations, recently told FE Trustnet recently that managers bullish on small and mid caps are living in the past and that he was holding a high cash weighting as a defensive position.
Artemis UK Special Situations and Investec UK Special Situations both favour more defensive strategies, especially the latter, run by Mundy.
Dampier says his contrarian style may be behind his outperformance since small and mid caps began to fall in March.
“Lots of those stocks that have gone up over the past five years have fallen 15-20 per cent recently and the FTSE doesn’t look like it has changed very much but there is lots of underlying differences in holdings with greater dispersion.”
Dampier thinks a hit to the small and mid cap space may be behind the underperformance of those funds that have lost money in 2014.
“There has definitely been a recent change of market leadership whereby momentum has gone out of small and mid cap stocks for the time being.”
“If small and mid caps are powering up then most special sits funds will probably do well as they are predominantly weighted there – around 70 per cent – so that has been the big factor over the past five years,” Dampier said.
“Special sits funds tend to have most of their money in that part of the market than the larger stocks in the FTSE. In 2012 and 2013 they did really well and so it would suggest a change of leadership – in the market – is causing it.”
UK small and mid caps have rallied over the past five years with a particular diversion in performance between them and large and mega caps apparent over the past two years.
The FTSE 250 has risen at almost twice the rate of FTSE 100 over two years, during which it rose 48.41 per cent compared to 24.6 per cent.
Performance of indices, over 2yrs
Source: FE Analytics
Despite its recent underperformance, Dampier recommends Blackrock Special Situations as he says the fund has recently suffered due its exposure to overseas earners but expects it to bounce back in the near term.
He also advises caution on the term Special Situations and its meaning to investors.
“It is just a marketing name and can mean many different things in different funds and the nature of these funds is that they go quiet for a while and will do something that is quite agnostic to their benchmark from time to time.”