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Special Situations funds are widely known to investors, largely down to the efforts of Anthony Bolton. Mr Bolton acquired legendary status by running the Fidelity Special Situations fund from 1979 to the end of 2007 and achieving an annual average growth rate of 20.3 per cent, far in excess of the average stock market growth over the same period of 7.7 per cent.

Mr Bolton puts his own success down to finding undervalued, overlooked stocks until the stock market discovers their potential and buys in, but this is only one of a number of strategies used by Special Situations funds.

There is no actual definition of what a Special Situations fund is, but it is a name often used by funds that adopt one or more of the following investment strategies. Investment in stocks where there are:

• Expected changes in value - through technological advances, change in management or where there are opportunities not recognised by the market.

• Mergers, acquisitions and offers - where there is significant scope for mispricing the assets on one side of the deal.

• Opportunities for growth - through products or services that benefit from a monopoly such as through barriers to entry or new innovation.

• Event-driven opportunities - such as changes in legislation requiring the use of products or services or changes in consumer attitudes.

Funds with this designation can often be "high conviction" where the manager puts his faith in a relatively small number of holdings or "contrarian” where they invest in areas that are unfashionable or unloved by the market.

In reality, the qualities that seem to appear in managers appointed to run such funds tend to be exceptional skills in individual stock picking and the ability to spot deeply hidden value. These skills really come to the fore when the mandate for the fund is relatively unconstrained and the manager is able to take significant positions in the opportunities he or she has found.

One of the managers I was talking to recently was very excited about a new change opportunity he had discovered. It would appear that the European Union is about to pass legislation that would require crematoria to filter mercury from fillings from their chimneys. The equipment to do that is relatively costly and is primarily made by a single supplier with a semi-monopolistic position protected by significant barriers to entry by new players. It was inspired thinking, but certainly took the shine off the excellent dinner we were enjoying at the time.

As I write, 27 UK Regulated funds bear the title, from eight different IMA sectors as geographically diverse as Europe and the US, but with 20 focusing on the UK generally or smaller caps. If we look outside UK Regulated funds there are several more funds and the geography spreads further to Japan and Asia.

Of the 23 funds that have posted one year to date figures the returns are widely diverse from the 3.25 per cent return posted by the Midas Special Situations portfolio to the Majedie Special Situations fund with -52.88 per cent. This is in reality a reflection of the widely different underlying investment approaches of the funds.

Incidentally the volatility of the funds inversely mirror the performance, with the lowest being the Midas fund and the highest being the Majedie fund with three times the volatility. This clearly reflects the current market, but also in a way reflects on one of the key issues of Special Situations funds. They are so different and will all respond differently to economic conditions. In short, there is no way to tell how Special Situations funds will do, but there is every possibility there will be some excellent performers among them.

These will inevitably include some of the seven highly rated funds. The UK Special Situations funds from Artemis, BlackRock and Investec, the Jupiter European Special Situations and the two funds that split out from the Anthony Bolton fund, Fidelity Special Situations and Global Special Situations. While it is difficult to benchmark this type of fund, six of those listed in the table outperformed the UK all companies average and the FTSE100 over one year to 30/1/2009.

The outperformance of these funds is all the more remarkable as the areas in which many chose to find their value was in small or mid-cap stocks which have suffered the most from the "credit crunch".

As for the future, markets are generally considered to be looking worse for UK-based investments than elsewhere, but Special Situations funds boast a wealth of investment management raw talent and ability. Combine that with what could undoubtedly be one of the broadest selection of investment special situations for a very long time and there is a recipe for considerable outperformance of the rest of the UK market. The skill of the managers as stock pickers combined with their ability to look through situations to determine good opportunities should stand them in exceptionally good stead and I would certainly expect the seven funds mentioned in the table to be leading the charge as and when a market recovery occurs.

While a few commentators are suggesting a significant market recovery this year an equal number are sceptical. Despite this the Special Situations managers have had an opportunity to adapt and adjust to the markedly changed circumstances of the current market and will be in a position to add value to their funds. This could potentially deliver performance relative to the market and in some cases in absolute terms as well. From this perspective Special Situations could do well whether markets improve soon or not.

From an investor's perspective it is very important to take care and good research backed by professional opinion is paramount. As we have seen, there have been some exceptionally good and bad performances from these funds. Typically the fund rating agencies are good at separating the good from the bad, but the other potential pitfall with these funds is the wide range of risk from the cautious to the adventurous. With respect to this, there are a number of websites and information systems that provide relative and absolute measures of the risks of funds, but if you are in any doubt, get a professional opinion.

Overall, it looks like it is going to be tough and in the UK especially, but a lot of investors are now looking to put money into the market to ensure they do not miss the upturn. The stock picking skills of the Special Situations managers could certainly go a long way helping investors make the best of a bad situation before and after the market turns.

Tim Collyer is head of investment solutions for Falcon Group