Investors shouldn’t write off the potential returns for recovery funds owing to the ongoing nerves surrounding global markets, according to Rathbone’s Joanne Rands.
The manager, who runs the £70m Rathbone Recovery fund alongside Alexandra Jackson, says that one of the biggest risks to markets right now is fear itself, and the prospect that negative investor sentiment could lead to a sell-off.
While many investors believe that the start to 2016 suggest a particularly torrid year ahead, Rands, who has more than 16 years of equity market experience, says that this year’s concerns are similar to those voiced at the start of last year.
“The only difference between this year and last year is that the fear seems to be more focused on the now rather than the future,” she said.
“I think what you’ve seen this month is everyone panicking and saying ‘this is it’. It’s really happening - we’re starting to see the unwinding of various bubbles around the world’, but the macroeconomic data hasn’t fallen off a cliff.”
“The risk is that people just get more and more scared and sell off of the back of that. But it doesn’t feel like market weakness is all over the regular press yet, and we’re still yet to see particularly heavy selling.”
This sentiment isn’t shared by everyone, however, and many investors have been turning to ‘safety’ in traditionally low-risk funds that pay a steady stream of income, or absolute return funds that aim to make a positive return regardless of market conditions.
According to FE Analytics, in fact, the MSCI AC World Value and Growth indices have taken a serious hit since the start of the year, having lost 5.5 and 4.94 per cent respectively.
Performance of indices in 2016
Source: FE Analytics
In an article published at the end of last year, the head of Investec’s value team Alastair Mundy told FE Trustnet we are in the throes of “value hell” due to a combination of too many headwinds in the market and too few attractively-valued stocks.
“Our industry always wants to be bullish, we always want to tell our clients that we’re either optimistically optimistic or cautiously optimistic, so we have got a bias. I just don’t see a huge amount to be optimistic about at the moment,” he said in December.
Rands though says that it would be wrong to tar recovery funds with a deep value brush, as many investors do, and adds that the team at Rathbone recovery are “completely paranoid” about stumbling into value traps.
Hargreaves Lansdown’s Adam Laird agrees and says that, so long as an investor’s portfolio is well-diversified and therefore able to handle higher levels of risk, the recovery space could be a good space to seek opportunities.
“I certainly think it can make sense. As a sector it involves often investing in smaller companies which do have the potential to outperform when markets recover. In times of volatility like now this is a market which can be riskier, and that’s something that investors need to be aware of,” he said.
“Rathbone Recovery has also done a reasonably good job over the last few years. The evidence we’ve seen suggests the team is quite good at stock-picking and that’s obviously a positive. We had a catch up with them in 2014 when they were expanding the team and we’re pleased to see that its strong performance has continued.”
The fund’s ability to navigate risk can be shown can be shown through its performance during last year’s choppy market conditions, when it provided a total return of 11.2 per cent compared to the FTSE All Share’s return of 0.98 per cent.
Performance of fund vs sector and benchmark in 2015
Source: FE Analytics
The manager partly attributes this to the fund’s bias towards mid-caps and smaller companies as they outperformed large caps last year, but emphasises that careful stock selection also contributed to its outperformance.
“It’s very much a stock-picking fund and we do have a bias towards the small and mid-caps, which I think is quite unique within the recovery space,” Rands said.
“The key thing we’re looking for though is companies that demonstrate recovering cash-flow returns. That’s what we’re really trying to identify. We’re not a traditional deep value sort of fund that invests in things with low price-to-book [ratios], we’re really focused on cash-flow and cash-flow returns.”
Another way she increases the downside protection of the recovery fund is to adhere to a strict sell discipline, pointing out that being able to sell something at the right time is just as important as being able to find a good idea in the first place.
As such, Rands and her team are continuously reviewing all of the holdings in the portfolio, which currently stands at 54 companies, in terms of position sizing and whether the stock should be sold entirely.
“If we think there’s been a deterioration in an investment case and we think it’s to do with structural issues then we’ll be looking to sell pretty much immediately,” she explained.
“If we think the issues are just cyclical and the company can ride it out over the next 12 or 24 months then we’ll adjust our position size accordingly.”
One example of a company the managers have reduced exposure to recently is Elementis, a FTSE 250-listed chemicals producer.
While Rands says it is a “great company”, it has been impacted by the slowdown in shale gas drilling activity.
“It’s had a few bumps along the road but actually it’s got some very good assets and we like that one over the longer term,” she said.
“Valuation is important too of course. We have soft price targets for companies and it just allows us to have discipline. If we think the recovery has become priced in then we sell out. If we just think there’s a change in the risk/reward ratio we’ll alter the position size, and if we just find a new idea that we think is a lot more compelling we’ll replace one of our current holdings.”
Since Rands and Jackson took over the helm of the fund in June 2014, it has provided a loss of 2.5 per cent, outperforming its peer average and benchmark by 0.71 and 4.58 percentage points respectively.
Performance of fund vs sector and benchmark under Rands and Jackson
Source: FE Analytics
The fund has a clean ongoing charges figure of 0.89 per cent and yields 2.38 per cent.
