The likes of Tom Dobell, Alastair Mundy and Julian Chillingworth, who all run recovery funds, look well positioned to beat their peer group in 2012 should the UK economy suffer, as most analysts predict, a period of no growth or even recession.
As the name suggests, recovery funds invest in companies that are going through a difficult time, have had some bad results or have had a change in management. The managers work closely with these companies to turn performance around and boost their stock market value.
"A lot of people are fleeing to quality at the moment and holding funds exposed to blue chip stocks, but small cap, recovery and special situations funds offer investors the chance to get some exciting returns in what is likely to be a really difficult market," said Chris Spear, managing director at Derbyshire-based IFA Spear Financial.
Spear says that if the UK economy falls on hard times then he wants to have the managers in his portfolio who specialise in companies that are up against the wall.
"The point of a recovery fund is to buy stuff that is out of favour, to be a bit contrarian to the market. Tom Dobell bought BP just after the Gulf of Mexico oil spill in 2010 and made a fortune," he said. "The advantage of owning this type of fund is that you’ll have access to a manager who understands when is a good time to take profits."
"Stock prices have moved around very unpredictably based on sentiment rather than fundamentals. Recovery managers have done the close company research and make it a priority to find stocks unloved by the market. Alastair Mundy also invests with this philosophy, his Investec UK Special Situations fund is best understood as a recovery fund."
There are many examples of recovery funds available to the UK retail investor, but the best known is FE Alpha Manager Tom Dobell’s M&G Recovery fund. According to data from FE Analytics it has returned 22.58 per cent over the last five years compared with 0.57 per cent from the average UK All Companies fund.
Performance of funds vs sector over 5-yrs
Source: FE Analytics
Kerry Nelson, managing director at Nexus Independent Financial Advisers, says that despite the name, recovery funds are not just for periods of financial recovery.
"Most of these funds are tried and tested in all types of market," she said. "People think they are only for one type of market but they’ve had consistent performance in all weathers."
"The M&G Recovery fund in particular has been consistent over the last 20 or 30 years. It comes in and out of fashion but Tom Dobell has an investment strategy that works. For the next few months the market is only likely to go one way and it is no good owning trackers when a recession hits. You need access to the very best stockpickers in your portfolio."
According to Spear, these types of fund are not as niche as their investment process may suggest, and the majority of investors can look to allocate a lot of their capital to them.
"In theory recovery funds should be quite specialist but there are some really mainstream funds out there," he said. "Dobell has described his product as a fund for mums and dads so he really thinks it has mass-market appeal."
"Smaller investors can be comfortable putting a lot of their UK equity exposure in recovery or special situations funds, maybe as much as 20 per cent of their portfolio. Larger investors should think about having about 5 or 6 per cent exposure."