IC Top 100 Funds update: M&G Recovery

The fund has underperformed for a number of reasons, in particular its investment focus and style. It targets unpopular or overlooked companies that its manager, Tom Dobell, believes will return to fair value in time. He 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 means the average holding period of the portfolio is around six years, and in a number of cases much longer.

Read our interview with Mr Dobell to learn more on how he invests

"Also, given that the fund's holdings are unlikely to resemble that of its peers it means that it can be an uncomfortable ride when equity markets rally, driven by macro events rather than stock fundamentals, as the fund will probably underperform, as it has versus peers over the past two years," say analysts at research web site FundExpert.

In the fund's first-half report Mr Dobell explains that, over the first six months of this year, the main detraction from performance was stock selection, particularly oil and gas producers. The three largest detractors were Australian listed African Petroleum, First Quantum Minerals (FQM) and Tullow Oil (TLW), although Mr Dobell maintains confidence in the latter two.

Limited exposure to telecoms also had an adverse effect.

"The improvement in the UK stock market has been led by investors seeking certainty of earnings and cash flows, meaning that so-called defensive growth stocks, making predictable profits and paying regular dividends, have been in the vanguard," he says. "With the rally in the stock market being driven by safe haven companies, the recovery strategy has faced some headwinds since the companies in which we invest do not really fit into that category. Companies facing uncertainty have been side lined and those that have disappointed investors have seen their shares sold unceremoniously. Our approach depends on investing while companies are facing uncertainty, often in the early stages of rebuilding their plans."

However, he is using the lack of investor interest to get investments at good prices. "Given the lack of interest shown by the broader investor community in recovery situations, the undervaluation of such companies has become significant and we have been able to invest in several businesses that we expect to deliver substantial value in the future," says Mr Dobell.

New additions this year include Lloyds Banking Group (LLOY), Royal Bank of Scotland (RBS) and Enterprise Inns (ETI).

A number of advisers are persuaded by the merits of sticking with the fund, including FundExpert:

"If you want a fund with an outstanding long-term record, clear value-style process and management stability, this is a fund to buy on underperformance. We know that:

■ Value investing outperforms in the long run.

■ The value approach has extended periods when it underperforms.

■ If you buy a fund like M&G Recovery you should do with the fund as the fund does with its holdings - be a long-term partner and holder."

Meanwhile, Adrian Lowcock, senior investment manager at broker Hargreaves Lansdown, adds that M&G Recovery offers something different to other UK equities funds in that Mr Dobell becomes really involved with his underlying holdings, taking a very activist shareholder role. Examples of this include Gulf Keystone (GKP), where Mr Dobell was involved in appointing four new directors to the board, and African Petroleum, which Mr Dobell continues "to engage with…over the opportunities for the company going forward".

Mr Lowcock adds that this fund has historically benefited from mergers and acquisitions (M&A), but that M&A activity has been weak for around four or five years. "This is a long-term investment for a minimum of five years," he says. "The fund has grown fairly large in size (it has assets of around £7.2bn), but it is suffering because this style of investment is out of favour. The fund doesn't target strong cash flow and dividends, which have been popular with investors, but in fact it is a good diversifier to equity income funds, and a recovery play."

Mr Dobell says that companies have repaired their balance sheets since the credit crisis of 2008 and built up large cash positions, which could mean an upturn in M&A, something anticipated by some other market participants.

Read more on when not to ditch a poorly performing fund

However, FundExpert says that if you are not prepared to wait and wish to buy a fund with momentum now you could consider Schroder UK Mid 250 Fund (GB0008528696), which is up over 20 per cent in the past six months. But FundExpert adds that more cautious investors should sit in cash for now.

If you are interested in mid-caps see our fund tip on Old Mutual UK Mid Cap Fund (GB00B1XG7999). And you could also check out our IC Top 100 Funds list for top performing UK equities funds, or a number of UK All Companies Funds with strong performance, including IC tips Royal London UK Mid Cap Growth Fund (GB00B4V70S51) (read the tip), Ecclesiastical UK Equity Growth (GB0008445982) (read the tip) and Cazenove UK Opportunities (GB0031092728) (read the tip).

Source: Morningstar as at 16 August 2013

Top 10 holdings as at 30 June 2013