What do Special Situations Funds Invest in?

Special situations funds aim to root out hidden gems - and based on performance this year, they're doing a decent job

James Gard 10 June, 2021 | 12:24AM
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UK special situations funds are among the best performers so far this year as the unloved value stocks they own have returned to favour.

Last year was a productive time for special situations fund managers to pick up bargains, particularly while UK oil and banking stocks were out of favour. Their long-term view appears to have paid off, and many of these funds have enjoyed the strong rebound in these sectors.

But if special situations fund managers pride themselves on being contrarian and not following the herd - just how unique are their portfolios? 

What do Special Situations Funds Invest in? 

We’ve looked in detail at five top-rated special situations funds to see which unloved stocks they own and how these differs from the index. We've focused on their top 10 holdings for the sake of simplicity.

What’s immediately striking is the diversity in the top holdings. Some 33 stocks out of 50 are only held by one of the five funds. These include Aim-listed textile rental company Johnson Service Group (JSG) with a market cap of £775 million and drinks maker Diageo (DGE), which is close to £80 billion in size.

Tobacco firm Imperial Brands (IMB) and oil major BP (BP.) are the most commonly held stocks, featuring in three of the five portfolios we looked at. Stocks which feature in two funds are Aviva (AV.), sales support firm DCC (DCC), GlaxoSmithKline (GSK), AstraZeneca (AZN) and Royal Dutch Shell (RDSB).

Highest Rated UK Special Situations Funds

UK special situations funds

There are two Gold-rated funds in this group, Fidelity Special Situations and Jupiter UK Special Situations, both of which have returned around 20% year to date. In their top 10 holdings, the funds have only one stock in common, Aviva (AV.), which is the second biggest holding in the Fidelity fund and the fifth biggest in the Jupiter fund.

Fidelity Special Situations has recently been upgraded from a Morningstar Analyst Rating of Silver to Gold, and features among our 10 Funds for a UK Recovery. Morningstar analyst Fatima Khizou praises manager Alex Wright’s “contrarian, value-orientated approach”. His stock-picking has been the main driver of returns and has helped it outperform its peers.

How do Special Situations Funds Invest?

Special situations funds are meant to be “benchmark agnostic”, meaning they can take concentrated bets away from the index and invest in medium, small and micro cap stocks if the manager thinks that's where the best opportunity is.

Morningstar fund analyst Robert Starkey praises Jupiter Special Situations manager Ben Whitmore in this regard: "Whitmore has continually shown the courage of his convictions in building the portfolio, which can look quite different from the benchmark at the sector and market-cap levels." 

But when the value style of investing is out of favour (such as last year), these funds can struggle. The flipside, or course, is they can outperform when these stocks make headway.  The FTSE AllShare is up around 9% in the year to date, and all our five funds are ahead of this. 

Top 10 Holdings of Rated Special Situations Funds

Stocks held by Special Situations Funds

UK large and mid-cap value stocks were badly out of favour last year, and thus represented some of the most compelling special situations opportunities in that period. But now they've caught up, any manager owning these stocks will now have weightings similar to the benchmark, which can limit the chance to outperform. 

For example BP (BP.) constitutes 2.91% of the Liontrust Special Situations fund and 2.57% of the index (Jupiter Special Situations fund has 5.47% of its portfolio in BP - more than double the AllShare index). A bet on BP will have paid off this year, as its shares are up nearly 30%, although this comes after a 40% fall in 2020.

How Special are Special Situations Funds? 

In most cases, the top 10 holdings of these funds vary significantly from the index. Aggreko  (AGK) makes up just 0.09% of the benchmark, for example, but is the second biggest holding in the Liontrust fund.

These special situations funds are also much more concentrated than the AllShare index, which comprises 601 stocks, compared to between 42 holdings (Artemis) to 97 (Fidelity) holdings in the fund portfolios.

Will these funds remain "special" as the market continues to re-appraise value stocks? Fidelity's Alex Wright thinks the rotation back into value is still only just getting started after years of growth stocks having the upper hand. "UK equities, and in particular value stocks, continue to look very attractively valued in a global context, a hangover of prior Brexit uncertainty and the disproportionate impact of the pandemic on the domestic economy," he says.

According to Morningstar analysis, the majority of the most commonly held stocks are undervalued. These include 5-star rated Royal Dutch Shell (RSDB) and Imperial Brands (IMB), which are held by three and two funds respectively. Seven other stocks have 4-star ratings, while only four stocks have a 2-star rating.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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James Gard  is content editor for Morningstar.co.uk