Mutual Funds

Mutual Funds Offer Ready-Made Diversification

While we normally focus on individual stocks, from time to time we like to look at mutual funds that focus on turnarounds. Mutual funds can be attractive for many investors because a single fund can provide fairly broad diversification across a large number of stocks. Unfortunately, there are very few mutual funds that really focus on turnaround investing. We had to struggle to come up with the small number described below that have turnarounds as at least part of their strategy. And even in those funds, turnaround investing is often just one of several strategies that the fund manager pursues.

In some ways the scarcity of turnaround-oriented funds just proves our assertion that turnarounds represent an inefficient – and therefore potentially very profitable – niche in the securities markets. Even professional investors tend to shy away from turnarounds because they require a somewhat different analytical approach from more mainstream stocks. Moreover, fund managers tend to avoid turnaround stocks because these stocks are usually underepresented in the inidices against which the managers are evaluated. The funds described below had mixed performance over the past year, with many of them underperforming the S&P 500 index. This shouldn’t be surprising in a year such as last year where large, mainstream stocks (such as those in the S&P index) were the best performers. However, there will be years when those large mainstream stocks will perform poorly, and that’s when funds like those discussed below, which go against the crowd, can really shine.

AMG Managers Skyline Special Equities’ subpar 2014 isn’t consistent with the fund’s superior long-term performance.  The current managers, who’ve been with the fund since 2001, look for companies trading at a discount due to company-specific problems that have led Wall Street to avoid the stocks.  The portfolio is focused on small and  micro-cap stocks.

Ariel Appreciation Investor is led by John Rogers, Jr. who founded Ariel Investments in 1983. He’s well-known for favoring out-of-favor stocks, such as Bristow and Interpublic Group, both TLrecommendations. The fund emphasizes the Financial Services, Consumer Cyclical and Industrial sectors and is heavily weighted toward mid to large-cap stocks.         

Avenue Credit Strategies Investor has only been around since 2012, but its manager, Avenue Capital Group, has been specializing in distressed debt securities since 1995.  The fund focuses on high yield bonds, bank loans and other distressed debt instruments.  Though 2014 was subpar, they've done well since inception, and we suspect the fund will do better when we see more defaults and restructurings.

Fairholme is headed by Bruce Berkowitz, a well respected manager who is known for concentrated bets, which are often in turnaround situations.  For example, recent filings show that American International Group and Bank of America (a TLrecommendation) account for 55% of the fund’s holdings.  Such concentrated bets hurt last year’s performance, but since inception, he has built a strong record.  He definitely eats his own cooking, personally owning about 5.5 million shares of the fund.

Fidelity Capital & Income focuses primarily on lower-quality debt securities, but also has about 17% in equity.  The fund does not shy away from defaults and restructurings.  Evidence of the fund’s ability to capitalize on troubled companies in uncertain times was its 72% return in 2009.  But that wasn’t just a flash in the pan – the fund is pretty consistently among the top performing high yield funds.

Fidelity Event DrivenOpportunities had a decent first year of existence, with solid performance that has continued so far in 2015.  The “event” in the name refers to the fund’s ability to look for specific fundamental changes such as a corporate reorganization, new management or even bankruptcy.  Small- and micro-cap stocks account for over 56% of the portfolio.

Franklin Mutual Shares has a long and distinguished history, with its first two managers, Max Heine and Michael Price, now considered among the all-time giants of value investing.  The current managers work hard to avoid value traps by looking for particular strengths, including management and financials to high-quality assets.  The fund often participates in distressed or restructuring situations.

GoodHaven belied its name with poor results in 2014.  Nonetheless, it has a good longer term record.  The fund has what one mutual fund analyst called “a deeply contrarian fallen angels strategy.”  The fund’s two co-managers have been doing this for a long time (they worked at Fairholme before starting GoodHaven), and we expect performance to bounce back.  The portfolio is rather concentrated, and with a few exceptions, is mostly focused on mid- and small-cap stocks.

Hotchkis & Wiley Value Opportunity seeks value opportunities created by “irrational investor behavior.”  The fund often buys stocks that are shunned by Wall Street.  American International Group is the fund’s largest holding, but TL-recommended financials Bank of America and Citigroup are among its top holdings.  The fund is rather well diversified across market capitalization.

Janus Contrarian Fund is diversified across market caps, but has only 50 names in the portfolio, and one half of the portfolio is in the top ten holdings.  The managers begin by canvassing a universe of overlooked stocks and then look for a catalyst that might change the dynamics, such as a new management team.

Keeley Small-Mid Cap Value focuses on  spin-offs, balance sheet restructurings and other event-driven catalysts.  The fund’s small- and mid-cap focus hurt performance in 2014 as smaller stocks underperformed the S&P 500, but longer-term results have been good.

Oaktree High Yield Bond Advisor is a new fund as of late 2014 that is sponsored by TL Recommendation Oaktree Capital Group.  The firm has a great reputation for distressed and lower-quality debt investing in the private equity arena, and this fund makes that expertise available to individual investors.

Putnam Capital Spectrum can buy either stocks or debt securities.  Manager David Glancy has a long track record of successful contrarian investing.  Glancy looks up and down a company’s capital structure to identify the best investment opportunity, which could be in its bank loans, bonds or equity.  Also, he does not shy away from concentrated positions or holding cash if he thinks it appropriate.

 

TURNAROUND MUTUAL FUNDS: GOING AGAINST THE CROWD

Fund

Symbol

NAV

5-Year Avg. Return %

1-Year
Return %

Total Assets $Mil
$ Million

AMG Managers Skyline Special Equities

SKSEX

40.16

18.57

7.13

1,400

Ariel Appreciation Investor

CAAPX

56.18

17.35

14.59

2,200

Avenue Credit Strategies Investor

ACSAX

10.79

NA

-2.80

2,000

Fairholme

FAIRX

34.87

7.58

-3.11

6,100

Fidelity Capital & Income

FAGIX

9.99

9.92

7.16

10,500

Fidelity Event Driven Opportunities

FARNX

11.56

NA

10.74

166

Franklin Mutual Shares

TESIX

30.44

12.37

11.55

16,000

GoodHaven

GOODX

24.05

NA

-7.84

339

Hotchkis & Wiley Value Opportunity

HWAAX

28.45

18.74

12.94

582

Janus Contrarian  Fund

JCNAX

22.45

13.85

12.92

4,400

Keeley Small-Mid Cap Value

KSMVX

14.58

16.64

5.45

304

Oaktree High Yield Bond Advisor

OHYDX

10.46

NA

NA

26

Putnam Capital Spectrum

PVSAX

39.38

20.00

10.27

10,200

Disclosure Note An affiliate of the Publisher owns securities of, and has other business relationships with, certain of the funds discussed in this article.

 

Read other articles from the March 2015 Turnaround Letter

 

                                                           

Identify & Profit from Distressed Investing

Free Report: Turnaround Investing Mistakes

Turnaround Investing Blog

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