Promising hunting ground

Fiona Hamilton 10.07.07

Anthony Bolton's impending retirement as manager of Fidelity Special Situations fund is not getting quite as much coverage as Tony Blair's departure from Number 10. Nor is it quite as imminent - Bolton expects to work in tandem with his successor, Sanjeev Shah, from September until
the year end. But it is probably more widely lamented among his followers, because he has served them exceptionally well, turning £100 invested in his fund at its1979 launch into around £13,000 today.

A special situations brief is particularly challenging because it is so wide ranging and almost everyone who tackles it, Bolton included suffers some bad years. The last 12 months have been dull by his standards, and he looked in very poor form in the late nineties. However, his refusal to back the dotcom boom was fully vindicated in the ensuing bear market and his recent caution could again prove correct.

Some of his competitors, such as Carl Stick of Rathbone Special Situations and the youthful James Ridgewell of New Star UK Special Situations, must be hoping that they can achieve a similar return to form. Stick's fund did very well in 2003 and 2004, but has languished since. He focuses mainly on smaller companies, and has a large exposure to the alternative investment market (AIM). The New Star fund had a traumatic time in summer 2006, which has left its one year returns in tatters; but Ridgewell has outperformed Bolton in the three of the last four 12-month periods, and has been doing well again recently.

Shah follows in Bolton's footsteps

Succeeding Bolton will be a stiff task for Shah, as Fidelity Special Situations' huge size makes it more difficult for it to sneak in and out of smaller companies as easily as most of its competitors. However Shah believes Fidelity's 71 pan-European research analysts give him an invaluable advantage.

Shah has a similar style to Bolton, with whom he has had frequent contact over the last eleven years. Both look for companies that are unloved or not widely followed. Both put great emphasis on meeting companies themselves - though Shah limits himself to around three a day. And both suspect that the four-year bull market could be running out of steam, and that any remaining bargains are most likely to be found among larger companies. Shah reckons that 90% of the UK market is fully valued, and as he only invests in companies which look at least 20% undervalued his choice has become very limited.

"These types of valuation anomalies are rare, so I am not constrained in my search by sector or whether a company is small, medium or large. I'm looking for turnaround and recovery situations, companies where the growth potential is not reflected in the share price, hidden jewels in companies or companies with corporate activity potential."

The Investec UK Special Situations fund has been doing well recently. Its manager, Alastair Mundy, shares Shah's belief that larger companies are currently the most promising hunting ground, so his top ten holdings include the likes of Royal Dutch Shell (RDSB), BP (BP-), HSBC (HSBA), Glaxo (GSK) and Vodafone (VOD). This makes him look as if he is hugging the FTSE 100 index, but Mundy insists he is doing no such thing. Instead, he thinks it has become too dangerous to invest in most medium to smaller companies, as they have been chased up to perilously high valuations - often in hopes of a bid.

Mundy uses screening systems to locate companies which have fallen more than 30% relative to the market, then scrutinises them closely to decide whether they deserved their mauling. He damaged his 2005/06 performance by turning to larger companies too early, but he is prepared to be patient.

Artemis better than Fidelity

The Artemis UK Special Situations has also raised its exposure to larger companies, although it retains around 40% in its traditional hunting ground of medium to smaller companies. Managed by Derek Stuart, it has an impressive record, having outperformed Fidelity Special Situations in four of the last five 12-month periods, and although it has grown a lot it remains much more manageable than its Fidelity rival. Stuart works closely with fellow Artemis founder, John Dodds, and they will soon be bolstered by Mark Niznik, who did well during five years at Standard Life.

Stuart is another to confess that he turned defensive too early, cutting back on mining and cyclical industries in favour of telecoms, water and bus companies, but like Mundy he is sticking to his guns. Artemis is not keen on holding cash in its funds, but it thinks that at this stage in the stock market cycle it is sensible for portfolios to be well diversified, with "a decent weighting in the cheaper, better value, mainstream, maybe boring, assets, but where the real value is."