Recovery funds look for companies that are unappreciated by the market for stock-specific or industry-wide reasons and aim to find those that they think will be capable of turning it around.
In theory the stocks should have greater growth potential, while also falling less if markets take a turn for the worse.
Here are five stocks that have suffered poor news-flow but that are being backed by recovery managers to turn it around.
Ocado
Ocado sells supermarket goods online and delivers them to people’s homes. It has struggled to turn a profit since flotation in 2010 and was believed by many experts to be on the verge of bankruptcy last year.
However, the company agreed a deal in the spring with Morrisons to distribute the supermarket’s goods online, and sentiment has turned towards it.
Harry Nimmo, manager of the Standard Life UK Smaller Companies fund, added the company to his portfolio in recent months. Nimmo has a good record of picking companies that have successfully used the internet to their advantage.
"The announcement of its joint venture with Morrisons puts the business on a sound financial footing, giving it a platform for strong growth," he said.
Since May, the stock has made 148.27 per cent, while the FTSE All Share has made just 5.8 per cent.
Performance of stock vs index since May 2013
Source: FE Analytics
Six funds hold it in their top 10, including Baillie Gifford British Smaller Companies, CF Odey Atlas and Fidelity UK Growth.
Qinetiq
Qinetiq was spun off from the Ministry of Defence in 2001 by the Labour government. It is involved in research into defence and aerospace engineering projects and sits on the FTSE 250 with a market cap of £1.3bn.
The company has been a favourite of FE Alpha Manager Alex Savvides for some time and is currently his eighth-biggest holding in the £89m JO Hambro UK Dynamic fund, at 3.2 per cent of total assets.
The company has had a difficult year, with its share price rising just 2.58 per cent compared with 21.17 per cent for the FTSE.
Performance of stock vs index over 1yr
Source: FE Analytics
This year the company suffered a pre-tax loss of £137m, having made £316m profits a year before, and it is forecasting negative earnings per share for the year ending March 2014.
Cuts to US and defence spending have hit the company badly but it remains the second-largest active bet in the JO Hambro fund.
It is also a major holding in the £74m FP Matterley Undervalued Assets fund, run by Henry Dixon, making up 2.3 per cent of assets.
Dixon also takes a recovery approach on his fund and looks for companies that are trading at low prices compared with their replacement costs.
Rumours in the market suggest that the company could sell its US arm, which, among other things, provides components to NASA, and this could give the share price a boost in the short-term.
No other IMA funds hold the stock in their top-10.
Morrisons
Morrisons is another stock to have fallen on hard times. It is the major supermarket to have been left behind as its rivals exploit the internet and switch to a model that favours smaller shops rather than superstores.
The tie-up with Ocado is one step the company is taking to resolve this situation, and it has piqued the attention of recovery managers.
It is a top-10 holding in the Schroder Recovery fund, making up 3.76 per cent of the portfolio, despite having lagged the index this year.
Performance of stock vs index over 1yr
Source: FE Analytics
This is a contrarian call, given that the company is one of the most-shorted stocks on the market according to a recent FE Trustnet study.
The Threadneedle UK Equity Income team also thinks the market is wrong.
Dixons
The Schroder Recovery team is also backing Dixons to turn around its fortunes. The electronics retailer is a top-10 holding in Jupiter Undervalued Assets and Marlborough Special Situations as well as in eight other portfolios.
UK retailers, especially those on the high street, have been deeply out of favour for a long time, although this is changing in line with improving economic news.
Dixons has been profiting from its rivals Comet and Jessop going under and has soared away since strong quarterly results in March when the company raised full-year growth expectations.
Performance of stock vs index over 1yr
Source: FE Analytics
The company had a strong Christmas last year.
BP
Many managers hold this for its dividend, but some, such as M&G Recovery manager Tom Dobell, hold it for its turnaround potential.
The company has long been suffering from the aftermath of the Gulf of Mexico disaster, with court cases still ongoing in an attempt to cut the compensation it has to pay.
The company is also suing the US government over the ban on it winning state contracts.
BP has also had problems in Russia, although these have finally been resolved in a way that is widely seen as positive for the company.
It has bought a 19.75 per cent stake in Rosneft, which opens up the possibility of exploration in the Arctic circle.
The company is Dobell’s largest holding, at 6.15 per cent of the fund.
