Following the herd is not always the best investment

Going against the crowd is not always easy. Eight months ago I wrote about three investment areas that had been battered and had the potential to stage a comeback. I pointed out that investors usually require patience and occasionally nerves of steel while waiting for the tide to turn in their favour.

The three areas I highlighted were Asia and the wider emerging markets (EM), certain areas of the global fixed interest complex, and commodities, particularly gold.

Performance of the five investment routes I suggested are highlighted in the first chart below (click to enlarge). The lion's share of gains from the clear leader, Aberdeen Asian Smaller Companies Investment Trust, were made in the past five months, with latecomers in this Money Observer Rated Fund rewarded with a 10% gain in the last month alone.

A similar pattern is seen in the wider global emerging markets fund, Sarasin IE Emerging Markets Systematic, which is an index-tracker with a novel twist.

Gold miners

It rebalances all of the country indices that make up the MSCI Emerging Markets index every month to equal weighting, thus ensuring that investors are not overexposed to big countries in the index such as China or Brazil or underexposed to small, potentially more dynamic countries such as Chile or the Philippines.

Investec Global Gold and BlackRock World Mining have been more modest plays on the contrarian theme, so far, although both of these Rated Funds have decent pedigrees, strategies and managers who should continue to reward investors well.

A dramatic upturn for gold mining shares revived some specialist funds' fortunes, with returns of more than 20% over the three months to 1 September but this turnaround has proved to be shortlived.

Where further patience is obviously required is Capital Gearing. Although the net asset value of this investment trust has plodded along in a pedestrian fashion, all the action has been in the relation between the share price and NAV.

The premium to NAV steadily fell this year until very recently, when it staged a rapid comeback from a small discount to an estimated 6.5% premium as I write.

Indeed this recent reversal in investor appetite for shares in this overtly value-oriented trust with a focus on wealth preservation has seen the share price leap to a 5% gain, year to date, putting it in the top quartile of the AIC UK growth sector.

That was then, this is now

I continue to believe there is merit in holding all five of these plays, although some are not as contrarian today as they were earlier this year, notably Asian emerging markets. Here we can expect to see some volatility in the weeks and months ahead.

Global investors have recently been piling into the shares of large emerging market companies via the cheap and easy route of exchange traded funds (ETFs), but the stronger US dollar (traditionally a negative influence on emerging markets) and the progressive winding down of quantitative easing in the US is beginning to take its toll on sentiment.

Nevertheless, John Higgins, chief markets economist at consultancy Capital Economics, reckons the much-improved global competitiveness rankings of 14 of the 23 countries in the MSCI Emerging Markets index in the past year will continue to show through in equity valuations.

"Overall, we expect EM equities to continue to outperform developed market [DM] equities over the next few years," he says, adding that "the valuations of equities in EM economies appear to be more favourable than DM equities".

Russia and emerging europe

Where else could investors look for contrarian, undervalued opportunities in current markets? One of the obvious candidates is Russia. Its bellicose attitude in Ukraine has resulted in tit-for-tat economic sanctions that have sent the benchmark RTS index reeling to a 50% decline from its 52-week high.

Investors could buy a passive ETF such as HSBC MSCI Russia Capped, but a dedicated investment trust such as JPMorgan Russian Securities, currently trading on a 15% discount to NAV, offers better value and active management to boot.

The Russia effect has further weakened the wider eastern European stock markets, which investors can access via an ETF such as db-x MSCI EM Eastern Europe.

Again, however, better longer-term gains should be achievable via an actively managed investment trust such as BlackRock Emerging Europe (BEEP).

It's trading on an 11% discount and also sports gearing of 7% - which will magnify any further losses but will also boost any underlying uplift in asset prices.

Optimism in europe

Further cause for optimism comes in a report from Deloitte, which highlights the fact that European (along with those in the Middle East and Africa) companies are hoarding cash and have built up €963 billion (£764 billion) in reserves, with €47 billion added in the last year alone.

While it's true that quoted companies that hoard cash aren't necessarily doing shareholders much good, there are three main reasons why this is potentially positive.

One is that it provides a refinancing cushion for many companies who have been turned away by weak banks in the eurozone; second it means if they do not use the cash via organic growth or acquisitions they will need to either return a lot of this cash to shareholders via higher dividends or share buybacks; and third, if they don't put this cash to good use and sentiment improves, they will become targets themselves from company bosses who think they can.

Finally, as I suggested eight months ago, it's often a good contrarian pointer to turn annual performance tables on their head to see which investment sectors have been doing poorly, as we've done below, sourced from our website.

Despite some stellar individual numbers from funds such as Legg Mason Japan Equity, I find it very interesting to see that Japan tops the leaderboard of sector losers.

I plan to top up my modest exposure, probably via a vehicle where I can hedge the exposure to yen, which would be a purer play on what I hope to be decent gains from Japanese equities in the year ahead.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.