Which fund managers have the capability to identify turnaround stories and how have recovery funds fared during recent bull markets?
What recovery funds aim to do is invest predominantly in the shares of companies that, at the time of investment, are out of favour with the stock market. The fund manager identifies hidden value in the fact that a sound (and sometimes new) management team is resolutely trying to turn the business around.
Often the fund manager is taking a longer-term view as the turnaround may be far from imminent. They are buying out-of-favour stock cheaply in the anticipation that the share price will rebound significantly when measures to improve the business start to show on the balance sheet.
The objective is to buy into this recovery potential and then sell for a tidy profit when this potential is realised.
Global brand turnarounds
Not all failing companies can be turned around, but there are plenty of good examples of companies that have seen their brand and profits recover after some tough times. Even global giants such as Apple have fallen from grace in the past.
Companies make mistakes and in Apple’s case it was when the board members lost faith in the company’s founder Steve Jobs and removed him from his post as CEO in 1985.
Following Jobs’ departure, innovation within Apple struggled and sales dropped markedly.
When he returned as CEO in 1997, Apple was staring at bankruptcy. He not only steadied the ship but went on to transform the digital music and mobile phone industries with the introduction of the iPod, the iPhone and iTunes.
Not every turnaround story is going to be as dramatic and culturally significant as Apple, but it shows how a change in leadership can turn a failing business into a market-leading one.
For fund managers, turnarounds don’t always happen. The new CEO brought in to move the business forward may be head-hunted by a rival. A merger that was much anticipated, could fail to materialise.
In some cases, unloved stocks remain just that. But the benefit of a portfolio of turnaround possibilities is that you don’t need every selection to be correct to produce a good return.
It’s arguable that a bull market is not the best time to find unloved or under-valued stocks. When markets are more bearish and there are indiscriminate sector sell-offs, there are opportunities to buy stocks of businesses (caught up in the negative sentiment) at a good discount.
In reality, there are always companies that offer potential despite weak points in their sector or business model – the onus is on finding them.
Fund manager skills
Some recovery funds have fared better than others in recent years and that is not overly surprising since in this ‘sector’ it is not always a case of comparing like with like.
As Justin Modray, IFA with Candid Financial Advice, explains: “Recovery funds are a clear example of where the skill and approach of the fund manager really matter. Despite generic ‘recovery’ and ‘special situations’ titles, the way in which these funds invest can vary widely.”
“For example, some managers focus primarily on smaller companies, while others focus on larger. And the geographical exposure and types of recovery situation vary too.”