The catalyst and the case: Unlocking equity returns through special situations - Angles & Perspectives Q1 2025

The catalyst and the case: Unlocking equity returns through special situations

Investors don’t have to look far to find sources of anxiety these days. Yet, despite pervasive uncertainty in markets, capital growth is needed more than ever, as people live longer and inflation continues its quiet assault on real savings.

Equity markets play a critical role in delivering this much-needed capital growth. However, at an aggregate level, global equity markets face some severe challenges and a multitude of risks: valuations and profits are high in the largest parts of the market (in particular the US), which is a headwind to future real returns. Furthermore, the macro landscape is deeply uncertain with an unpredictable global trade environment (geopolitics and erratic tariff policies playing a role), geopolitical tensions and polarisation, high and sticky interest rates and the prospect of a slowdown in growth. For investors in South African equities, both domestic and global risks remain top of mind.

In this context, the value of idiosyncratic equity exposures, i.e. those with unique characteristics (or special situations), is very clear. Special situations hold the ability to deliver uncorrelated returns, given the outcome is wholly dependent on corporate events or transactions. Special situations are a valuable component of our equity investment toolkit at PSG Asset Management.

Why special situations deserve closer attention

Special situations encompass a range of corporate actions and transactions that include mergers and acquisitions, share buybacks, asset sales, debt reorganisations, spin-offs or security issuance, and can materially impact a company’s value or alter the future course of a business. Benjamin Graham defines a special situation as “... one in which a particular development is counted upon to yield a satisfactory profit in the security even though the general market does not advance.”

Due to their ‘special’ nature, special situations provide a driver of company performance that is not dependent on economic growth and that can be material in delivering investor outcomes, even in turbulent market conditions. In most cases, equity returns are unlocked as the market prices for a corporate or regulatory event.

As such, these events clearly have the potential to unlock value for investors, and importantly, they are not directly dependent on the economic growth trajectory.

How special situations can aid the investor journey and client outcomes

Investing in opportunities driven by special situations can help to drive overall portfolio returns, even during difficult periods in the market, given that they add a source of return that is not correlated to market performance (and perhaps the rest of the equity portfolio). If special situations are well understood and entered into at an attractive price, they can introduce equity-like returns at a lower risk profile than that of other equities. Having a collection of special situations in your portfolio helps diversify this idiosyncratic risk even further.

Special situations are often overlooked by the broader market for the following reasons:

• The broader market often finds it difficult to price their impact correctly, as they require deep research and a good understanding of the businesses in question. Sometimes the situations are fairly complex.
• Special situations often exist in smaller/misunderstood/under-the-radar companies. This means that mid-sized managers are often better placed to take advantage of them.

In particular, we find that our 3M investment process is well positioned to unlock the value on offer from special situations, since it leads us to find opportunities with inherently attractive characteristics that the market is missing. Specifically, special situations are often not fully reflected in valuations, and can help add a margin of safety to the holdings that make them more attractive. This margin of safety is considered together with the quality aspects of our process - the management and moat assessments. Our preference for doing our own, independent research provides another unique advantage, as fully unpacking the impact of special situations requires a detailed analysis of the company in question. As such, our team has a track record of extracting alpha in this space. Previous highlights include enjoying the fruits of corporate transactions in Imperial Logistics, Long for Life, Royal Bafokeng Platinum, Old Mutual’s managed separation, Prudential plc’s demerging of M&G plc and Jackson Financial, and Woodside’s merger with BHP’s energy assets, to name a few.

Examples of current special situations

There are a number of current special situations underway in our portfolios. We are watching their development with interest, and believe all of them have a good prospect of contributing to portfolio returns in the future. Importantly, we expect these events to occur at varying times, and the potential to introduce uncorrelated return drivers into our portfolios is very attractive.

Special situations add to our investment toolkit

At PSG Asset Management, we are firm believers that there are always opportunities for astute investors. Special situations are a case in point, where investor outcomes are not dependent on overall market returns. Our idea generation process loves special situations, an area we have had considerable success with. By carefully combining shares driven by various sources of return, we believe we can construct robust portfolios that are well suited to navigate a variety of market environments. Special situations form a valuable component of our equity investment toolkit and have added substantially to our investment performance over time. We look forward to seeing how our existing book of special situation investments unfolds over the coming years.