Richard Plackett returned in October 2014 from a 6 month sabbatical to re-join co-manager Roland Arnold at the helm of the BlackRock UK Special Situations Fund.
Performance relative to the peer group has been poor since January this year. The managers attribute this, in the main, to a sell-off in small and medium sized companies, where the fund is more heavily weighted than its peers. Higher risk small and medium sized companies outperformed their larger counterparts for a number of years but have underperformed since March this year as investors looked to lock in profits.
Performance has also been negatively affected by the fund's bias to high quality companies (see below) rather than undervalued stocks. With cash and bonds yielding very little, investors have flowed into the equity market searching for income. Purchases have generally been focused on undervalued companies offering high dividends causing high quality, growth oriented companies to underperform. There have also been a number of stock specific issues, namely the poor performance of Xaar, Oxford Instruments and Aviva. These holdings have generated strong returns for the fund over the long term but disappointed over the past 6 months.
The managers define a high quality business as one with the following attributes; successful management; a strong market position; cash generative; a good long term track record of growing the business; and a strong balance sheet.
The managers believe the strong stock market performance over the past few years has been led by market sentiment rather than the underlying earnings growth of companies. At the beginning of this year, they felt this was about to change. In the short term, valuations are often affected by fear, greed, trends and sentiment while over the long term, a more important driver of share price returns, in the managers' view, is earnings growth. They felt it would be higher quality companies that would be able to produce earnings growth, which in turn would be reflected in the share price. However, it has been evident over the past year that investors were happy to forgive profit warnings, and share prices stayed fairly constant.
The fund's performance over the past two months has been more promising, coinciding with a shift in investor sentiment. Firms have been punished when issuing profit warnings and share prices have fallen more in line with earnings expectations. This has affected quality companies less and the fund has had relatively few holdings issue such warnings.
What changes have the managers made?
The growth of shale production in the US has contributed to an oversupply of oil. Coupled with slowing demand from China, Japan and Europe, the oil price has fallen dramatically over the past few months. The managers reduced the fund's exposure to oil and commodity companies early on, protecting it from the worst of these falls.
The expectation of an interest rate rise has waned recently, benefiting countries where it was thought a rise was imminent. The managers have increased exposure to economically-sensitive companies focused on the UK and US consumer, who have more disposable income due to the falling oil price and low interest rates.
Our view on this fund
Recent performance has been disappointing with our analysis suggesting stock selection has detracted from returns. The long term track record of the fund remains impressive although past performance should not be seen as an indication of future returns. We are happy for the fund to retain its place on our Wealth 150 list of favourite funds across the major sectors.
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