Finding uncorrelated alpha in special situations

Special situations – recovery opportunities that are undergoing restructuring or management change or those that are less well covered or understood – are not a traditional mainstay of income portfolios but offer a prime hunting ground for Invesco Perpetual’s Mark Barnett.
His two UK equity income trusts, Perpetual Income & Growth Investment Trust (PIGIT) and Edinburgh Investment Trust, have a significant slug of assets in special situations and uncorrelated assets whose risk-adjusted returns are not closely linked to the broader earnings cycle. PIGIT has 28.9% across special situations and uncorrelated assets while Edinburgh has 22.4%. Neville Pike, a product director on the fund manager’s UK equities team, highlighted the holdings at Sub35’s first Edinburgh event.
Key themes of the portfolios include companies involved in the fields of insurance, including catastrophe insurance, non-standard finance, such as litigation financing and sub-prime lending, and private equity. “These things will generate a return whatever is happening in the marketplace,” said Pike.
He highlighted Burford Capital as a classic example of the growth potential. Barnett took a position in it when it was founded and floated on the stock exchange in 2009.
“[Then] litigation finance didn’t really exit – these guys really created the industry,” said Pike. “Very simplistically, if you are a Glaswegian tech company and you have beef with Samsung, just to pull a name out of the air, and you think there’s been a misappropriation of your intellectual property and want to take out a law suit… Burford can provide a solution for that – take the risk and provide the capital.”
The company also provides capital to legal firms fighting big cases and is today six times larger than its nearest competitor. It is a high margin business with return on invested capital of 75%. “It started out as a small seedling and is now the biggest single active position across all of Mark’s portfolios, including PIGIT and Edinburgh,” said Pike.

Best ideas

He also spoke about the opportunities within company ‘families. “A bit like how Unilever owns Magnum ice-cream and Dove soap and Dirt is Good and Flora margarine, we’ll invest in IP Group – a top company – and then selectively cherry-pick the best ideas and invest direct in those,” he said.
Oxford Nanopore, a private company involved in next generation DNA sequencing, is an example of a direct investment within the IP Group family. A disrupter in science and medical technology, Invesco first invested in Oxford Nanopore in 2011.
The cost of investment was £98.2 million versus a valuation based on its latest funding round of £242.7 million, said Pike, a chartered accountant and self-confessed “old-fashioned numbers man”.
He drew on the words of Chinese philosopher Lao Tzu – “the wise man is one who knows what he does not know” – to leave a message with the audience.
Speaking at The Caves in the Scottish capital’s Old Town, he said: “If I’ve learnt anything over my career in the City it’s that there’s a lot I don’t know [and] secondly, not to be worried that I don’t know. If you go into a meeting and find you don’t understand stand up and say you don’t understand because if you don’t understand probably half the other people in the room don’t either.
“You can’t understand everything and if you do you have eliminated all risk and without risking there is no opportunity. There is inevitably going to be risk in all strategies – that’s desirable, that’s opportunity. What we try to do is manage that risk within sensible limits and diversify some of that risk away so that we can capture real alpha.”

Watch Pike’s presentation