It always feels a bit cheap kicking a manager when they are going through a tough time of it, especially one who has made their investors very wealthy over the long term.
But, unfortunately, that is the case with Tom Dobell and his M&G Recovery fund – which is underperforming the FTSE All Share over five and 10 years and is now the worst performing portfolio in the 250-plus IA UK All Companies sector over one and three years.
Of course, any criticism of Dobell’s lacklustre performance of recent years should always be coupled with his longer term numbers.
It is, for example, no fluke that M&G Recovery outperformed both the sector and index in each of Dobell’s first 10 years in charge. That performance profile is still reflected in Dobell’s tenure on the fund, as M&G Recovery is outperforming its peers and benchmark by close to 40 percentage points since he took charge in March 2000.
Performance of fund versus sector and index under Dobell
Source: FE Analytics
Nevertheless, as the graph above shows, that performance has tailed off considerably over recent years.
In fact, FE data shows it has underperformed against the sector and FTSE All Share in four out of the last five calendar years. What’s worse, the fund is bottom quartile and underperforming against the FTSE All Share once again in 2015.
Source: FE Analytics
One of the most difficult aspects for Dobell’s investors to swallow is that M&G Recovery’s underperformance has come during a time when markets have been in, well, ‘recovery’ mode.
For instance, the sector’s list of top quartile funds is littered with similarly value-orientated funds, such as Standard Life Investments UK Equity Unconstrained, Invesco Perpetual UK Growth and FP Miton UK Undervalued Assets.
Its recent performance seems to have been the final straw for many investors, though, as its AUM (having peaked at around £8bn three years ago) currently stands at £4.5bn with outflows of close to £2bn over the past 12 months.
Dobell has had to defend his performance on a number of occasions, pointing out that given he invests in companies which are out of favour, in difficulty or whose future prospects are not fully recognised by the market, there will always be periods when his fund will underperform.
In his most recent webcall, he pointed out that while it has been tough few years, he is sticking to his long-term approach which he fully expects to bear fruit in the future.
“Generally speaking, I think the fund and the UK market are a terrific place for people to invest and I’m pretty optimistic,” Dobell said.
“Yes, we have had a tough time but if you go back over the 46 years of this fund there have been other periods where we have had a tough time. It’s part of the job, we’ve got a sense of humour, thick skin and we are working as hard as we can in the interest of our customers to position the fund in the best place.”
Dobell says there have been a number of factors which have worked against the fund over recent years, trends he now says are starting to reverse.
Firstly, he says his ‘value’ strategy has not been conducive to market environment as defensive, mega-cap dividend paying equities have led the market as ‘tourist’ fixed income investors have been forced into riskier assets by central bankers in search of an acceptable level of yield.
FE data backs up this assessment, as ‘bond proxies’ such as consumer staples (and to a lesser extent healthcare stocks) have comfortably outperformed the wider equity market over recent years.
Performance of indices over 5yrs
Source: FE Analytics
However, with bond yields rising and interest rates expected to increase over the coming years, Dobell says this headwind could start to act as a tailwind for the fund as investors look more at company fundamentals rather than being swayed by macro themes.
The manager also says the muted M&A environment of recent years has hurt the fund. Again though, with rates so low and management teams being encouraged to acquire growth, he expects this to change and subsequently act as a positive for M&G Recovery.
“If the stock market doesn’t recognise the value of a company, then sooner or later a competitor or third party will,” he said.
“With low interest rates and refinancing available, there is more confidence now than there has been for some time. We’ve had three [acquisitions] in the fund over the past six months or so but more widely we are seeing evidence across the board of companies participating in M&A.”
“I’m pretty certain we are going to see more of that and we are absolutely in the centre of that.”
Equilibrium’s Mike Deverell also points out that the Dobell’s historically high weighting to miners and oil & gas stocks, which originally helped the fund to massively outperform during the ‘commodity super-cycle’, has hurt performance more recently as prices have fallen and emerging market growth has slowed.
“In essence I therefore think past outperformance and recent underperform is at least partly down to his views on commodities,” Deverell explained.
However, what should existing investors do? It has to be said that the reasons for the fund’s underperformance (the preference for bond proxies and lack of M&A activity) have been given for a number of years now.
It is also true that UK equity investors have a wealth of top-performing ‘value’ managers to choose from apart from Dobell, such as Nick Kirrage and Kevin Murphy, Alex Wright and George Godber who have all had to operate in the same environment.
Keen-eyed readers will also remember that this journalist has a vested interest in M&G Recovery; given it was my fund pick for 2015. My reasons for choosing it were simple – Dobell has a long and successful track record who seemed due a rebound, had underperformed and was already holding undervalued companies and is now managing a far smaller pot of money.
Quite sadly though, and while there is still time for that to change, since that prediction the fund is still underperforming and has seen further outflows.
Performance of fund versus sector and index in 2015
Source: FE Analytics
Ben Willis, head of research at Whitechurch, says that although it may feel difficult cutting ties with M&G Recovery, investors shouldn’t feel uncomfortable selling after this period of underperformance.
“We don’t own it and we haven’t done for some time now. Even now, I don’t think he is instilling enough confidence to make us think that a buying opportunity may have opened up. I think that is telling given that we are not even considering the fund right now,” Willis said.
“I’m not saying it is finished, but it shows just how damaging this period of underperformance has been.”
Premier’s Simon Evan-Cook also sold the fund a number of years ago not because of the quality of the manager, but because of its surging AUM.
He points out that the fund will always go through periods of underperformance (he says investors should look at its performance during the early 1980s when it was down by 60 per cent relative to the UK equity market) but that the fund (as it has done in the past) will outperform over the full market cycle.
However, he says size has been Dobell’s biggest headwind and will continue to be an enemy for future returns.
“Even at £4.5bn we aren’t comfortable and, given the choice, we would much rather choose Tom Dobell running a £1bn fund,” Evan-Cook said.
“When you are a deep value investor you are very limited in terms of size because you can’t take those big positions in smaller companies. Twelve years ago, this fund was roughly 50 per cent in small and micro-caps and today that figure is 20 per cent.”
He added: “It has been a tough time for ‘value’, but if you are manager who can pick opportunities without being hindered by size, you can transcend that headwind against your style.”
Willis agrees that there are circumstances in which Dobell (pictured) can outperform again in the future, such as a higher interest rate environment and an uptick in M&A activity. 
However, he says it is becoming harder and harder to assess in which backdrop the fund is likely to out and underperform – a key metric for investors trying to build a diversified portfolio.
On top of that, even if those trends lead to outperformance, Willis says investors can find funds which are better suited to playing those themes.
“Of course, interest rates could well rise but when is that going to happen? The market is finding it difficult to price it in and you’ve got to question whether that will be the catalyst which will improve performance.”
“Yes, he might well outperform because of it but, to be honest, I know a lot of other funds which could do better in that environment. I think now is the time to assess your position in the fund.”
He points out that while other value funds like Schroder Recovery and CF Miton UK Value Opportunities’ weightings to small-caps will have helped their outperformance over recent years, their nimble size enables them to find those opportunities and take meaningful positions – unlike with M&G Recovery.
All in all, Willis says investors should sell – an argument which is supported by Hawksmoor’s James Clark.
“Following the long period of outperformance, the reasons behind the period of underperformance haven’t been well-communicated with investors,” Clark said.
“You have to ask what the catalyst is for a sustained improvement in performance. I think it’s fair to say that the ‘quality/risk aversion headwind’, which the fund has faced for over a year, may be calming, and I would back the need for a revival in M&A activity.”
He added: “But you have to ask what the opportunity cost is of holding M&G Recovery instead of a favoured UK special situations/recovery-style fund, of which there are a few very strong alternatives.”
