SOFs can be a diversification tool for investors seeking alternatives to conventional large, mid, or smallcap portfolios.
Special Opportunities Funds (SOFs) aim to profit from stock price movements triggered by corporate or economic events.
The latest entrant in this category is Motilal Oswal Special Opportunities Fund, which recently launched a new fund offer (NFO).
Six other asset management companies offer these schemes and have cumulative assets under management (AUM) of Rs 40,800 crore.
Where do they invest?
SOFs invest in companies navigating through periods of disruption.
"These disruptions could stem from mergers, demergers, regulatory changes, management shake-ups, or internal restructurings. The idea is to identify businesses that are fundamentally sound but temporarily misunderstood or mispriced due to these events," says Nirav R Karkera, head of research, Fisdom.
"The key characteristics of these funds include capitalising on short-term market dislocations, active and focused management, and investment of capital in quality businesses at lower-than-fair market valuations," says Parul Maheshwari, certified financial planner.
Global factors, innovations, and emerging trends can also create opportunities. Fund managers assess such situations to determine if they are favourable for equity investment.
"The US tariff reset and domestic policy tailwinds are creating sequenced, time-bound dislocations. Our fund will deploy dry powder into these catalysts to buy quality at a discount," says Ajay Khandelwal, fund manager, Motilal Oswal AMC.
Potential for high returns
These schemes can deliver outsized gains if events play out favourably.
"If the fund manager accurately identifies a special situation and the event plays out as expected, the resulting re-rating of the stock can deliver meaningful upside," says Karkera.
Varied outcomes
Outcomes tend to vary. Over the past year, the best-performing SOF returned 15.7 per cent, while the worst delivered minus 10.8 per cent.
"While some stories may play out in the short term, some may take longer to play out or may not play out as expected. Hence, there could be divergence of returns in the near term," says Maheshwari.
Portfolios differ widely, as they are not bound by sector, theme, or market-capitalisation related mandates.
"The path to value creation can be bumpy. Delays or changes in expected event can lead to extended periods of volatility or even loss. Timing and execution play a crucial role. Getting either wrong can weigh on performance despite sound reasoning," says Karkera.
Other risks include events failing to materialise or being already priced in.
"A large chunk of the portfolio is built by buying into stocks anticipating a flow of events. Many times, the news may not work in favour of shareholders or may already be discounted by the market," says Maheshwari.
"The risks in SOFs include catalyst delay or failure, liquidity and execution risks in small- and midcaps, policy or regulatory shifts, sizing, process and key-person risks, and concentration amplifying mistakes," says Khandelwal.
Diversification tool
SOFs can be a diversification tool for investors seeking alternatives to conventional large, mid, or smallcap portfolios.
"They typically maintain a flexible mandate, searching across sectors and market caps to uncover opportunities where short-term uncertainty may give rise to long-term value," says Karkera.
These schemes are best suited for experienced investors.
"Investors with a higher risk appetite and who understand the risk associated with special situations can invest," says Maheshwari.
"Investors with a long-term horizon of five to 10 years should consider these funds. They should allocate at least 10 per cent as a satellite position to optimise long-term returns. Short-term investors and traders should avoid them," says Khandelwal.
Investors new to equity markets should also steer clear of them.
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Feature Presentation: Aslam Hunani/Rediff
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