Nick Kirrage and Kevin Murphy took over management of the Schroder Recovery Fund almost nine years ago. During a recent meeting with Nick Kirrage, he recalled the advice he was given by his predecessor, Ben Whitmore, upon taking the reins: 'if you do not have at least one company in the portfolio going bust each year, you are not taking enough risk'. In my view this sets the scene for a recovery fund quite nicely.
Under the current managers' stewardship, the fund struggled during its first two years. Their contrarian approach naturally leads them to invest in undervalued companies and, at the time, there were few opportunities that met their criteria. In 2006/07 we were reaching the end of a strong bull market, meaning many companies looked overvalued.
In 2008/09 global markets collapsed. It proved an incredibly tough environment for fund managers. Yet at the time Nick Kirrage thought: 'if there is no recovery now, then when?' With plenty of value on offer in 2009, the fund subsequently performed exceptionally well, although it has not always been a smooth ride.
In today's markets Nick Kirrage sees greater opportunity in undervalued larger companies. In managing the portfolio he asks the question - what is cheap, why is it cheap, and is it big enough to buy? Recovery stories are often shunned by investors, yet if you can identify a successful turnaround situation, the rewards can be huge. Investors need to consider the likelihood of a company's share price falling further, and not improving again. Companies will do everything in their power to stop this and while some will succeed, others will fail.
Despite stock markets generally performing well in recent years, the managers have still managed to find pockets of value. For instance, investors' perception of banks remains poor. Yet the banking sector benefits from high barriers to entry from competition. While the government has attempted to break these down, retail banks have retained a loyal customer base, many of whom remain reluctant to transfer their accounts to a new company.
Furthermore, Nick Kirrage points out that most banks have seven-to-ten times the amount of capital they had prior to 2008. This provides quite a large margin of safety. He believes banks will return to being natural dividend payers in due course and, in his view, much of the money they used to pour into investment banking is now more likely to be distributed to shareholders through dividends.
Two of the fund's largest holdings are in pharmaceutical firms AstraZeneca and GlaxoSmithKline. Nick Kirrage believes the two stocks represent good value and are both paying an attractive dividend. Tesco is the fund's third largest stock. The supermarket has maintained decent market share in spite of recent turmoil, while determined management at the company's helm could also see its situation improve.
The fund operates a concentrated portfolio which enables each holding to make a significant impact on returns although this is a higher-risk strategy. The fund can also have exposure to smaller companies and derivatives should the manager see fit which adds further risk.
Our view on this fund
Recovery funds are very much the antithesis of any benchmark-aware or tracker fund. This type of investing requires patience, fortitude and understanding. Nick Kirrage and Kevin Murphy remain as enthusiastic about recovery investing today as they were nine years ago. Patient investors could be rewarded over the long term, however, a recovery approach to investing can be risky, as companies can stay out-of-favour for long periods of time.
I believe by investing in a number of holdings, the winners could hopefully outpace the losers over the long term. Buying what feels incredibly uncomfortable at the time can be extremely difficult. Yet perhaps that is the secret to successful investing - if it feels too easy, it probably will not make you a dime.
The fund does not currently feature on the Wealth 150 list of our favourite funds across the major sectors. The IA UK All Companies sector is highly competitive and we believe we already have a strong line-up of managers in this sector. That said, we have been impressed with the performance of this fund under the current managers' stewardship and we will continue to monitor its progress closely.