Why ‘special situation’ funds are nothing special for their investors

Benjamin Graham, known as the father of value investing and the author of Security analysis, has classified corporate events including merger, sale and liquidation of a business unit, litigation matters against the company, and the separation of businesses into special situations. These special situations present good buying opportunities for investors.

Neil Bahal, Founder & CEO of Negen Capital, said in an interview with mint in October 2022 that investing in special situations is an enhanced form of value investing. He cites the example of US-based Berkshire Hathaway, a textile business that failed before Warren Buffett took over the company. “Buffett’s takeover of the business for $14 a share changed the company’s DNA. It sticks to chocolates, furniture and even insurance. The business has completely changed direction and this is what you would call a special situation where some events happen and change the DNA of the business,” added Bahal.

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However, investing in exceptional situations is also a very high-risk investment strategy and has serious implications if the investor’s call fails.

There are three special case themed funds in India with a total assets under management (AUM) of almost $9,400 crore—ICICI Pru India Opportunity Fund, Axis Special Situations Fund and Aditya Birla Sun Life Special Opportunity Fund. However, these funds follow a broader mandate of picking stocks based not only on corporate actions but also on opportunities presented by industry- and economy-related trends. As a result, these schemes, which have invested in between 44 and 72 stocks, have diversified portfolios unlike a typical special situation fund, which typically holds a concentrated portfolio.

An interesting observation is that the portfolio of each of these three funds is more or less similar to an existing fund offered by the same asset management company (AMC).

ICICI Pru India Opportunity Fund

Launched in January 2019, this fund is the oldest fund with the mission of investing in three types of special situations — temporary crises in a company, sector or economy; change regulations; global events—offer good buying opportunities.

Over a three-year period, the fund has achieved a high CAGR (compound annual growth rate) of 26%, supported by the value investing style currently favored by the market.

However, a closer look at the portfolio reveals that the fund is similar to AMC’s Value Discovery Fund, run by the same fund manager— Sankaran Naren. Both funds have about 32 stocks in common, representing 82% of the India Opportunity fund’s portfolio, as of November 2022.

Bharat Pareek, product manager – private wealth manager, ICICI Securities, said, “both the value discovery fund and the Indian opportunity fund have made similar changes to their portfolios. in the past one year. The latter is recommended to clients as a value option rather than as a special situation fund.”

ABSL Special Opportunity Fund

Aditya Birla Sun Life Mutual Fund merged its previous Special Situation Fund, a diversified equity program, into the Aditya Birla Sun Life Equity Fund in April 2018 at the direction of market regulator Sebi on the classification of mutual fund programs. On October 23, 2020, the fund launched the ABSL Special Opportunity Fund.

Like the ICICI fund, this program also seeks unlimited opportunities in company-specific events.

Mahesh Patil, the fund’s chief investment officer, explains how they find opportunities for the fund from industry changes such as growth in the chemical sector, supported by a ‘China plus one’ strategy. . He also explains the company’s strategy of finding value in a specific event, citing the example of the fund’s investment in an electric company that recently spun off one of its business units. He declined to name the company, citing fund policy. The fund is geared towards the large-cap segment and has 38 shares in common with the Aditya Birla Flexi Cap Fund, which has also made significant investments in blue-chip companies. 38 stocks make up 76% of the Special Opportunity Fund’s portfolio.

Axis . Special Situations Fund

Axis Mutual Fund, known for its growth investing style, introduced a Special Situation fund that focuses on companies that disrupt business models and also others in such an ecosystem.

“We are trying to find the companies with the highest growth potential in their fields. Also, a lot of times, the valuations of these funds can’t be lower,” said Ashish Naik, fund manager. The fund’s portfolio, with holdings like Zomato and InfoEdge, also reflects reflect the same thing.

The Axis Special Situations Fund is the only program in this category with international exposure (approximately 27%, as of November 2022), advised by UK-based Schroder Investment Management He also focuses on disruptive philosophy.

However, this fund is similar to the Axis Growth Opportunity Fund, which falls into the large and mid cap categories. The fund also invests abroad with advice from Schroder. Of the 73 stocks held by the Axis Special Situation Fund, 35 stocks (61% of the portfolio) are shared with the Growth Opportunity fund.

Are these relevant now?

Santosh Joseph, an AMFI registered mutual fund distributor, is not currently associated with special situation funds. “Most diversified funds with multi-cap or large-cap flexible caps will capture most of that money in their existing portfolios,” he added.

Koushik Mohan, who was a special situation fund manager at MOAT PMS until a few months ago, strongly believes that mutual funds can implement the current investment style in any of their diversified funds, such as a value fund or a hedge fund.

“The portfolios of all three special-case funds are skewed towards large-cap funds. I believe the real value in special-case funds will be created from the small and mid-cap space,” said Rushabh Desai, a Mumbai-based mutual fund distributor.

Desai, who is also the founder of Rupee with Rushabh Investment Services, said, “Investors can definitely live without that kind of special situation. Any fund manager of flexible capital strategy funds can take advantage of the same and change the portfolio according to the dynamics of the market.”

Investors should be aware that there are a number of special situation funds in the PMS (portfolio management services) space that follow an investment strategy more true to their name. (see table).

Vishal Dhawan, Founder & CEO of Plan Ahead Wealth Advisors, emphasizes that special situation funds in the PMS space can only strategically open up when there are such opportunities to capitalize on. He gave the example of Unifi PMS, which has a ‘Spin-Off’ fund that focuses on spin-offs, and said the fund is no longer accepting funding as opportunities in this category may be limited.

Mohan, now a lead analyst at Ashika Institution Equity, cautions investors to be patient when investing in a truly exceptional circumstances fund as it can sometimes take a long time before shareholders witness the benefits of ‘unlocking the value’ of those companies.

Should you invest in these?

There is nothing special about special situation mutual funds in India. The benefits of investing in these schemes can be achieved by allocating your funds to any of the well managed diversified mutual fund schemes in India.