Restructurings, mergers and acquisitions, stock-index deletions and other company-specific catalysts drive the stock picks of Arvind Navaratnam, the portfolio manager of Fidelity Event Driven Opportunities.
Formally launched today, the new offering invests in U.S. stocks that the Boston-based Navaratnam believes are temporarily mispriced. This could be because of a positive development that he hopes to recognize quickly, and before the stock goes up. Alternatively, it could be a negative development, such as a dividend cut, that results in a stock price falling by more than what he believes is warranted by the company's fundamentals.
The fund focuses on small- and mid-cap stocks, which are less widely followed by the analyst community and therefore are more likely to be mispriced when a material event occurs. The fund does not engage in short-selling.
Navaratnam, a Harvard MBA graduate who has 10 years of investment-industry experience, joined Fidelity Investments as a special-situations analyst in 2010. As part of his research process, he has compiled a checklist of more than 50 special-situations attributes that have historically resulted in permanent losses of capital. While no potential investment will have a perfect score with nothing on the checklist, Navaratnam says the list is useful in conducting due diligence and assessing risk.
Navaratnam intends to hold 77 to 125 stocks in the fund, representing a cross-section of different types of special situations. The fund's mandate is similar to that of the US$167-million fund with the same name that is sold to U.S. investors.
Also managed by Navaratnam, the U.S. fund was launched in December 2013. Too new to have a meaningful track record, it has gained 4% in the year to date to Oct. 31. That's less than half of the 9.9% return for its Russell 3000 benchmark, as measured in U.S.-dollar terms.
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Navaratnam cautions that event-driven investing requires patience. The stated performance objective for his mandate, as noted in a third-quarter performance summary for the fund sold in the U.S., is to outperform the Russell 3000 over a "normal" market cycle.
As has already been experienced by U.S. investors, Navaratnam's short-term results will be volatile. In the third quarter, for instance, the U.S.-based fund lost 6.9%, while the Russell 300 was essentially flat with a gain of 0.01%.
The biggest drag on performance during that period was Civeo Corp. CVEO, which provides accommodations to the oil and gas industry. The fund bought Civeo in the second quarter after it was spun off from its parent. In late September, Civeo's shares lost nearly half their value after management disclosed a steep decline in the company's Canadian business.
Navaratnam operates without sector constraints, so the fund's sector weightings will look very different from its market benchmark. This is reflected in the holdings of the U.S.-domiciled fund, which as of the end of September held 44.5% of its portfolio in just two of the 10 major sectors: industrials and consumer discretionary. Navaratnam says sector biases tend to even out over the longer term.
Moreover, Navaratnam says event-driven investing, compared to more mainstream equity mandates, is less influenced by macroeconomic conditions, such as the levels of inflation or interest rates. Among several past examples of special situations he cited at a recent Toronto meeting with analysts:
- The deletion of printing company R.R. Donnelley & Sons Co. RRD from the S&P 500 in December 2012 because the company's market capitalization had declined. As Navaratnam explained, such events can create favourable entry points to build positions in a stock, since indexers are forced to sell.
- A Schedule 13D filing with the U.S. Securities and Exchange Commission in September 2012, in which an institutional investor disclosed it had acquired a 13% stake in the office-products retailer Office Depot Inc. ODP. (The SEC requires 13D filings when beneficial ownership of a publicly traded company exceeds 5%.) By systematically researching and keeping track of the outcome of 13D filings, Navaratnam aims to take advantage of acquisitions that are likely to cause a stock to outperform the market.
- The restructuring that led to the initial public offering in November 2012 of shares of Delphi Automotive PLC DLPH. The IPO, which involved debt being converted to equity, prompted forced selling by debtholders that weren't allowed to hold stocks. This, in turn, led to mispricing of the auto-parts supplier, which went on to make robust gains.
In general, says Navaratnam, senior management of a company may have an incentive to downplay a positive event over the short term, if their stock options are being priced at that time. This, too, creates, stock-buying opportunities.
Fidelity Investments Canada's new fund is available in a range or purchase options for investors who deal with full-service brokers or dealers. These include Series A, which has several deferred-load options, and the front-end-load Series B, whose 1.85% management fee is 15 basis points cheaper than Series A. Fidelity also offers fee-based and monthly-pay series, but there is no reduced-fee Series D for discount-brokerage clients.
