Fund profile: M&G Recovery

The M&G Recovery fund "invests in companies which are out of favour, in difficulty or whose future prospects are not fully recognised by the market".

The fund itself would fit that definition after a dismal performance over the last three years prompted significant outflows by disgruntled investors. The key question, however, is whether the fund will recover, or whether it has completely lost its way.

In a frank interview with Money Observer, Tom Dobell, who has managed the fund since 2000, expresses a mixture of contrition that its investors have suffered from his underperformance and frustration over the circumstances that caused it.

It has, he says, been a "humbling experience". "Everyone can see that the sum of my efforts has been something less than I would have hoped for. I am not trying to hide; I have disappointed a lot of people."

Ahead over 10 years

Back in 2011, it all looked very different. Dobell's record up until then had been excellent - so good, in fact, that the 10-year figures, and those for his entire tenure, are still ahead of the sector.

Since then, however, the returns have been abysmal and the fund is now propping up the bottom of the performance tables over one, three and five years. While the three-month figures offer a glimmer of hope of a turnaround, Dobell says: "That is obviously a very short time and there is a lot of ground to make up."

Dobell's approach is markedly different from that of other fund managers in the sector - "perhaps more different than we had anticipated", he says. He identifies companies that are unloved by the market, perhaps because they are in a difficult trading period or need a change of management, but where he sees that there is significant potential for improvement.

He is not a passive investor, waiting for the recovery to happen, but plays an active role, working with management to get the performance back on track.

That applies equally to large companies such as BP and HSBC - the top two holdings in the fund, where he has regular meetings with directors - and to smaller holdings such as GW Pharmaceuticals, where he has been waiting 12 years for a return on its cannabis-based drugs to treat epilepsy.

He is also a long-term investor: while the average holding period among institutional investors is just nine months, his is six years. That is an increase from the long-term average for the fund of five years, although the average holding period has been falling - it had touched six and a half years.

Big stakes

He is a strong supporter of his companies: since 2012, he has participated in 35 refinancings or other fundraisings by companies in the portfolio, constrained only by the limit that he can hold a maximum of 20% of a company's shares.

Moreover, he takes big stakes. Overall, he holds only around 80 companies - a small number for a fund of almost £5 billion; Morningstar, the fund rating agency, said that in September 2014, 37% of the fund was invested in companies where its stake was between 5 and 20% - a significant concentration of risk.

However, though Dobell makes no excuses for his poor performance, he points to the "unusual economic conditions" of recent years. Quantitative easing has kept interest rates low and affected investors' behaviour, and a global slowdown in growth and low interest rates have created "cold persistent headwinds" for the fund.

Mergers and acquisition activity - one of the main ways in which the Recovery fund realises value from investments - has been low, although there are now signs of a pickup. In the three years to end 2014, there were only three deals among the fund's companies.

But already this year, there have been another three: Advanced Computer Software has been acquired by a US private equity company, Pace Micro Technology is also being acquired by a US business and Synergy Healthcare is merging with a US rival.

All have been in the fund for some time. "Obviously I do not invest in companies because I expect them to be taken over, but if I can achieve a sensible outcome, at the right price and in the right circumstances, the returns can be exceptional," says Dobell.

Inflow/outflow swings

He has also had to deal with significant inflows following a prolonged period of outperformance in his first 10 years, and outflows as this has deteriorated: at one point, the fund had assets of more than £8 billion. Dealing with such swings would be difficult for any fund; for one which takes such long-term bets and such sizeable stakes, it is a significant challenge.

Dobell admits it has been "a factor" in the underperformance, although it is hard to quantify the exact impact, and that it has made things more difficult. "But it is a fact of life for any open-ended fund, and recovery funds ought to be better placed than others to deal with it."

He hopes that most of the performance-related outflows are now over, but says that he and M&G have been "at pains to explain to our customers the nature of a recovery fund". These funds will, inevitably, be both higher-risk and more volatile.

M&G Recovery has a long pedigree, having launched in 1969, and Dobell is only the third manager. It has had difficult periods before, but has remained true to its strategy, and Dobell does not intend to change his approach now.

"I am not in the business of changing what I believe is a strong investment formula. It is all about patience and common sense. We are fundamental, bottom-up stock-pickers. But we do need to be better at converting the potential we see to outperformance of the stock."

The long-term, focused approach means Dobell runs the risk of becoming too close to the companies he backs, perhaps failing to sell when the potential is not realised, or holding on too long instead of taking profits.

Too close to sell

"I have thought about this a lot and it is very difficult to separate the hindsight from the judgement," he says. "But I work with a group of quite exceptional, extremely capable, experienced people, who put this issue to me on a regular basis."

He does admit, however, that the recent wave of redemptions has focused his mind. "I will not tolerate passengers. I want to be a long-term investor, and perhaps I am more patient than the average UK fund manager, but I have got a responsibility to customers."

One of the areas depressing performance has been resources, which account for around a fifth of the fund. The industry has had a turbulent time, hit by the slowdown in China in particular but also weighed down globally by the collapse in oil prices.

But Dobell says that real assets, such as commodities, have always been a core holding of the fund. "I'm pretty positive. It is all about mispriced risk. I believe a lot of these companies are run by very good people and have high-class assets."

He sums up the outlook by referencing his favourite game of cricket. "Batting conditions have improved a lot. Previously, it was hard to know how the ball would play on an unpredictable pitch. But now the bowlers are easier to read and the pitch is more true."

Interest rates will start to normalise, which should mean a gradual end to the "momentum and yield frenzy" which has been driving markets and undermining his long-term, patient approach.

His own investors will hope that he is right, and the fund's fortunes are turning. If not, their patience will be further tested.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.