Mark Dampier: ''Basket cases' could be bargains for investors hunting for value'

Recovery stories are often shunned by investors, yet if you can identify a successful turnaround, the rewards can be huge

Nick Kirrage and Kevin Murphy took over management of the Schroder Recovery Fund almost nine years ago, from their successful predecessor Ben Whitmore.

In a recent meeting with the duo, Mr Kirrage recalled well the advice he was given by Mr Whitmore on taking the reins: "If you do not have at least one company in the portfolio going bust each year, you are not taking enough risk."

In my view, this sets the scene for a recovery fund quite nicely. Under the current managers, the fund struggled in its first two years. Their contrarian approach naturally leads them to invest in undervalued companies and, at the time, there were few that met their criteria. In 2006-07 we were reaching the end of a strong bull market, meaning many companies were viewed as over rather than undervalued. In 2008-09 the market collapsed and the financial crisis was headline news week after week. It proved an incredibly tough environment for fund managers. Yet at the time, Mr Kirrage thought: "If there is no recovery now, then when?"

With plenty of value on offer in 2009, the fund subsequently performed exceptionally well. In today's markets Mr Kirrage sees greater opportunity in undervalued larger companies. He asks what is cheap, why is it cheap, and is it big enough to buy? Recovery stories are often shunned by investors, yet if you can identify a successful turnaround, the rewards can be huge. Investors need to consider the likelihood of a company's share price falling further, and not improving again. Some companies will fail, others will succeed.

Despite the strong stock market performance in recent years, the managers have still managed to find pockets of value. Investors' opinion of banks remains low, yet the banking sector benefits from high barriers to entry from competition. While the Government has attempted to break these down, retail banks have retained a loyal customer base, and Mr Kirrage points out that most banks have seven to ten times the amount of capital they had prior to 2008. He believes banks will return to being natural dividend payers in due course. Much of the money they used to pour into investment banking is now more likely to be distributed to shareholders through dividends.

Two of the fund's largest holdings are in pharmaceuticals groups AstraZeneca and GlaxoSmithKline, and some readers might be surprised to hear that Tesco is the fund's third-largest stock. Yet this is a supermarket that has maintained significant market share in spite of recent turmoil. Determined management could also turn the situation around.

Recovery funds are the antithesis of any benchmark-aware or tracker fund. This approach requires patience, fortitude and understanding – not only from fund managers, but individual investors. As long as a recovery investor maintains a good spread of shares, and does not bet the farm on any one sector or share, the winners should hopefully outpace the losers over the long term. Buying what feels incredibly uncomfortable at the time can be extremely difficult. Yet perhaps that is the secret to successful investing – if it feels too easy, it probably will not make you a dime.

Despite the stress that must come with managing a fund such as this, Mr Kirrage and co-manager Mr Murphy remain as enthusiastic about recovery investing today as they were nine years ago.While a recovery approach to investing can be risky, as firms can stay out of favour for long periods of time, the long-term rewards for patient investors can be remarkable.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit hl.co.uk