BP and other recovery stocks

The manager of the giant M&G Recovery fund is a classic recovery investor, aiming to start investing in companies when they are 'unloved' (which he calls being at stage 1), hold them while they stabilise and recover well (stages 2 and 3), and then sell them when they are mature (stage 4). This all usually takes between three and five years. The fund's approach is to be a constructive shareholder, often working closely with management to help companies reach their full potential.

Companies that he includes in his stage 1 (the unloved stage) include BP, Stobart Group and Coal of Africa Limited, while companies that he considers mature are Associated British Foods, Sainsbury's and Amec. "When a company is mature and in stage 4, we are actively exiting. We want as much of the fund as possible in stages 1 and 2," he says.

The investment strategy is clear: he only invests in companies that he understands, that he trusts, and companies that can influence their own fate. "We like to back the underdog with strong potential," he says. "We don't invest in new issues – they are not recovery stocks. The call from a lady in America about Facebook was a very short conversation."

M&G Recovery Fund: return relative to FTSE All-Share Index

Source: M&G. Table shows the M&G Recovery Fund Sterling A class shares, net income invested, compared to investing in the FTSE with reinvested dividends.

He talks about his investors in the fund as the 'mums and dads' who are investing for the long term. "We are long term investors – and I really mean it," he emphasises. "We will buy up to 20 per cent of equity in a company and will stick through it thick and thin if the company is doing a good job."

"Our average holding period is 20 years. The biggest redemption is on our investors' death. Our priority is to help investors rather than grow funds for the sake of it. I'm not interested in accumulating assets for customers with a short-term view."

Nevertheless, during the global financial crisis in 2008 and 2009, he took the opportunity to refresh the portfolio. In 2009, he introduced 25 new holdings, of which he still holds 18. Half of the holdings have been introduced since 2009. "There are 30 holdings that we are serious about – we hold more than 1 per cent of the fund in each." (See box for these 30 holdings.) In total, there are 96 companies in the fund, which he says will not reach more than 100.

His top holding in the fund is BP, making up 5.7 per cent of the portfolio (he has increased the fund's holding in the oil giant this year). Describing BP's management as "on probation" with an "underwhelming chairman", he puts BP in his stage 1 of the recovery cycle. "The company's capacity is awesome, but its management is not. The Macondo oil spill is still damaging sentiment. This is a classic recovery stock. On a five-year view, BP will justify shareholder's sleepless nights.

"BP has done very well from a derisory base of £3 or £4 a share. But it has not even kickstarted yet. Compared to pre-Macondo trading at £5.50, it should do more than that.

"The cash flow coming off assets would imply BP's value is greater than where we are. The company will become lunch for someone else in the industry if it doesn't get going quickly.

"The American litigation is problematic. But we're looking for leadership from BP and for shareholders to be put at the top of the list. They have been further down the list for a while."

Another holding that he singles out is Mothercare, in which he has held shares for 10 years. "We've paid £1.50 a share in the past. It went up to £7 last year." While Mothercare is beset with problems in the UK, including total change of management and competition in the high street, he points out that the international business is thriving. "We went to India and saw first hand what is going on," he says. "There are 26 million new Indians born every year. While Mothercare has 100 stores in India, it will soon have 300. It's an absolute classic recovery stock as it weathers its problems in the UK and thrives everywhere outside the UK high street."

M&G Recovery is a predominantly UK fund (82 per cent of the fund), with 50 per cent invested in FTSE 100 companies. "Eurotunnel is our most foreign company, but I would argue that half of it is English," he quips. He also invests in Aim stocks which make up 24 per cent of the portfolio: "Although just under a quarter of the portfolio, Aim is half the work – it's an extremely innovative area, but it's a bit like chasing cats."

"Our newer holdings are more in the consumer area than in the past. I like companies that make things and have good technology."

At present, he is finding lots of opportunities in consumer stocks. Holdings in this sector include Homeserve, Inchcape, easyJet and C&C Group.

The portfolio is well spread across industrial groups in the market – apart from financials. "I have been cautious about financials for some time," he says. "Banks are not run for the benefit of shareholders. The only one I'd cross the road for is HSBC. The others can go out the back door as far as I'm concerned. I find it difficult to understand the accounting in banks. I can find 50 other companies before I get to a bank. Banks have abused their position and taxpayer guarantees."