Going against the crowd is never easy, but some investors make a habit of it by deliberately targeting stocks, sectors or entire markets that have fallen out of favour in the hope they swing back into fashion. This strategy is known as contrarian investing, and while it can be riskier than following the herd, it may also bring long-term rewards, if you get it right.
Today, for example, a contrarian investor might shun big US tech stocks like Nvidia, which have skyrocketed in 2023.
The magnificent seven big US tech stocks have been driven to new highs by the hype over artificial intelligence, but many analysts fear they are starting to look expensive and overbought.
A contrarian investor wouldn’t go anywhere near them.
Instead, they might invest in FTSE 100 house building stocks like Barratt Developments or Taylor Wimpey, whose shares have bombed as investors fear a property price crash.
As a result their share prices are cheap and they offer ultra-high high dividend yields of 8.31 percent and 7.72 percent respectively.
While dividends are never guaranteed, most companies aim to increase their shareholder payouts over time.
Better still, Barratt and Taylor Wimpey’s share prices may rebound when the mortgage crunch eases.
The problem is nobody knows when that will be and investors could suffer more pain along the way.
It’s not easy being contrarian, but it can be highly lucrative.
The best-known contrarian investor of all is US stock guru Warren Buffett, who famously said that he aims to “be fearful when others are greedy and greedy when others are fearful”.
He’s now worth around £100billion. At 93, Buffett is still running his Berkshire Hathaway investment vehicle, and still going against the grain.
Taking a contrary view can be highly rewarding, said Darius McDermott, managing director of Chelsea Financial Services and FundCalibre. “You can uncover some really good opportunities, pay less for them, and reap the rewards when everyone else realises they got it wrong.”
It can also be risky, as investors may have good reasons to be fearful. “Even if you make the right call, it could take a long time for your thesis to play out,” McDermott said.
He suggests that a contrarian may be tempted to buy a Chinese investment fund today, as the country has been hit by bankrupt property giant Evergrande Group, president Xi Jinping’s authoritarianism and US sanctions on vital computer chip exports.
McDermott is personally wary of China but said it could tempt those who can stomach a high level of risk and volatility.
If interested, he recommends two funds, FSSA Greater China Growth and JP Morgan China Growth & Income. “Neither are run by contrarian managers but they are in a contrarian asset class.”
The UK stock market is another contrarian call. It has been out of favour since the financial crisis, and Brexit controversies have not helped.
It could be in a sweet spot today. The problem is that investors have been saying that for years and it hasn’t recovered.
Smaller UK companies have done particularly badly and contrarian investors might consider TM Tellworth UK Smaller Companies and TB Amati UK Listed Smaller Companies, McDermott added.
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Blindly buying shares that have tumbled in value can lead you into a trap as the business could go bust, said Jason Hollands, managing director of fund platform Bestinvest.
This means you have to research any stock carefully before buying it. Look for sustainable revenues, loyal customers, and a track record of steadily increasing its dividends.“Ideally, target a business or sector that is fundamentally sound but temporarily out of favour.”
Some fund managers make a career of being contrarian, such as Alex Wright, manager of the Fidelity Special Situations Fund and Fidelity Special Values investment trust. “Both invest primarily in UK shares, especially small and medium-sized companies that are especially unloved at the moment,” Hollands said.
Wright’s top holdings include FTSE tobacco giant Imperial Brands, insurers Aviva and Phoenix Group, and defence manufacturer Babcock International.
Hollands also rates contrarian duo Ian Lance and Nick Purvis at Redwheel Partners, who manage the Temple Bar Investment Trust. “They are backing the unloved banking sector with holdings in NatWest and Standard Chartered, and have also built sizeable positions in fossil fuel giants BP and Shell.”
Almost 80 percent of their portfolio is invested in the UK, Hollands says. “The managers recently said it is time for UK investors ‘to come home’ as cheap valuations, cheap sterling and high dividends make a compelling case.”
Global investors have largely abandoned the UK. Today, our stock market is cheap and hated, which makes it one of the biggest contrarian opportunities of all. We should all hope it swings back into fashion some time soon. When it does, contrarians will take their gains and start looking for the next trouble spot.
