MICHAEL DE LA HUNT: The road to profit may be paved with special situations in 2023

A special situation is an unusual event that compels investors to buy a stock or asset in the belief that its price will rise. It assesses the underlying fundamentals of an asset (that investors would normally use to pick their investments) against a calculated attempt to profit from a potential rise — or fall — in the valuation that the special situation is able to present.

Generally it refers to an event that may reveal an undervalued security, and therefore a potentially profitable investment opportunity. These have been alluring to market players over the past few years but have come into sharp focus after the horror show of 2022 against declining market prospects in 2023.

SA investors would be well advised to keep a close eye on trusted and transparent funds offering investment opportunities in terms of special situations, given that our local economy will battle to position itself for growth any time soon. According to S&P, our fourth-quarter GDP numbers are likely to be disappointing due to record load-shedding, high inflation, continued supply problems and weak demand. 

S&P’s GDP forecast was based on the ratings agency’s latest purchasing managers’ index (PMI), which indicated that new business declined for the third time in four months in December. This has been compounded by the latest announcement from Stats SA, which revealed that company liquidations surged upwards of 30% in December amid a tough operating environment (with direct reference to the after-effects of Covid-19 in this high-inflation environment).   

The S&P Global SA PMI — which tracks business trends across the private sector, including mining, manufacturing, services, construction and retail — fell by 0.4 points month on month to 50.2 towards the end of 2022. Generally speaking, any figure below 50 indicates a contraction in economic activity — once again detailing inert growth within our formal economy. 

The Reserve Bank’s monetary policy committee meeting in January resulted in a repo rate increase of 25 basis points to 7.25%, which certainly shows a less aggressive rate hike than we experienced towards the end of 2022. We can only hope that rate increases will slow down in line with those of the US Federal Reserve. Either way, our economic outlook remains as steady as a tightrope — everything remains in balance until you decide to take the first step on the line towards the other side. 

Special situations may pave the way to profit during such uncertainty, both locally and abroad. Thankfully, SA isn’t ahead of the curve this time around. Businesses and their profits have been at the mercy of global demand and supply issues, the war in Ukraine and multiple recessions. Investors looking to grow and preserve their wealth in 2023 may find they are more likely to yield a satisfactory profit by investing in a special situation, even if the global market continues to underperform due to present circumstances (which will remain largely out of our control).

Understanding special situations, and the opportunity they provide investors, will be a critical undertaking for anyone seeking to protect their wealth this year.

Special situation investment opportunities can take many forms and may involve a number of different asset classes. More often than not, a special situation arises from breaking news stories or rumours of news that may be just about to break. Think along the lines of tender offers, mergers, acquisitions, bankruptcy, litigation, stock buybacks and any other event that might affect a company’s short-term prospects. You’ve probably already had a few come to mind, simply by reading through that list. (According to Bloomberg, US firms announced a record $1.26-trillion of share buybacks in 2022 alone.) 

Special situations generally involve a combination of debt-like downside protection with the potential for equity-like upside participation in stressed, distressed or event-driven situations, where underlying assets may be discounted due to market disruption, liquidity or an unsustainable capital structure. 

The main takeaway here is that a special situation aims to exploit such events. And we will have to if we are to navigate the tough times ahead. According to the UN’s World Economic Situation & Prospects 2023 report, world output growth is projected to decelerate from an estimated 3% in 2022 to 1.9% in 2023, marking one of the lowest growth rates in decades.  

While our global economic climate remains in distress, a growing trend to identify and seize special situations may help investors find the creative solutions they need, across a range of complex global scenarios affecting our growth, output and profits. 

Investors seeking opportunities through special situations should meet fund managers who aim to yield attractive returns to their capital partners by innovative means. These funds should seek to provide timely and sturdy advice, quickly, to empower investors with the knowledge they require to react to changing commercial demands and business drivers in 2023 and beyond.

That said, risk will remain a factor in any investment. The global economic arena is subject to changing circumstances daily, which will continue to affect its stability. 

Certain elements of this risk can be mitigated (albeit to a limited degree) by ensuring you engage with firms whose core values are underpinned by high levels of trust and transparency. Thankfully, SA’s regulatory and fiscal framework remains stable for now. We are comfortably positioned to benefit from global events and the special situations they may present to local investors, specifically those aiming to prioritise wealth preservation and generation this year.

• De la Hunt is CEO and cofounder at Ion Capital Partners.