special situations
I was reading in the Financial Times earlier today that the China Special Situations fund has not been doing particularly well lately and decided I’d write about it. The closed-end offering, Fidelity sponsors, is traded on the London Stock Exchange and run by Anthony Bolton, a portfolio manager who made his reputation through his long tenure with Fidelity’s UK-oriented special situations fund.
Before I do, I realized I should write something about what a “special situation” is and how it differs from a run-of-the-mill growth or value stock.
what they are
To my mind, a special situation stock is one that:
–offers the possibility of very high absolute returns, where
–returns will be based on factors that are specific to one firm or a small group of firms, and
–where understanding the relevant factors requires a lot of specific company knowledge (and not just awareness of general industry or macroeconomic developments, or of the general information contained in the financial statements).
Many times a special situation stock is relatively small and has few analysts following it. Sometimes, returns are dependent on the occurrence of specific events.
risks
Generally, special situations have a lot of stock-specific risk. The event may not happen. The detailed securities analysis may be incomplete or wrong. New competition may appear from out of the blue.
Examples:
–a company may have privileged access to an essential raw material that is about to come into shortage. Rare earths might be a current instance.
–a firm may own key intellectual property, like patents or copyrights. At one time, the Japanese company Pioneer was one of two companies that held basic patents for CD players. For many years, royalties from this patent (now expired) exceeded 100% of the company’s net income. In another country, that fact would have invited takeover or management-led restructuring.
–a company may have two divisions, one that makes money and one that has losses. By allowing investors to see the performance of each separately, with, say, growth investors bidding up one part and value investors the other, breaking the company apart may unlock value.
–a firm may be a likely takeover target, at a stock price that would be a large premium to the prevailing level.
–Merger and acquisition investing involving companies already being bid for–on the idea that the final bid price will be significantly higher than the market now realizes–is a narrower form of this.
–a company may have significant off-balance sheet assets, such as big potential/realized tax losses, or unproved mineral reserves, whose value isn’t well-understood.
–a company may be developing a revolutionary new product that’s big enough to make a dramatic difference to company profits, as Apple was with the iPod or the iPhone a half-decade ago, or Monsanto was with genetically modified seeds at around the same time.
what they aren’t
–well-known
–dependent on general macroeconomic forces
–easy to figure out.
That’s it for today. China Special Situations on Sunday.