Why now is perfect time to be a contrarian investor

Interactive Investor is 21 years old. To celebrate, our top journalists and the great and the good of the City have written a series of articles discussing what the future might hold for investors. Here's Fidelity Investment Director Matthew Jennings on the value of contrarian thinking.

Like Interactive Investor, Fidelity Special Values also recently celebrated its 21st birthday. Although the economic and investment landscape has changed significantly over the past two decades, the fundamental principles underlying the trust's investment strategy have remained constant.

We apply a contrarian, bottom-up approach to managing a well-diversified portfolio of shares in mainly UK-listed companies.

To be a contrarian investor means to focus your attention on stocks and sectors that have fallen out of fashion in the market and trade on cheap prices due to a lack of demand.

The chief advantage to this approach is that, if done well, it improves the balance of risks and rewards by limiting your downside and maximising potential upside.

It takes a particular mindset and disciplined approach to do contrarian investing This is because companies that are out of favour have probably disappointed investors in the past, meaning current expectations are low, and therefore the chances of further disappointment leading to steep falls in share prices are lower.

On the other hand, if things improve, the share price can rise significantly as the market responds to this better than expected news. Investing against the tide is a psychologically difficult thing to do.

Humans are social animals, and behave socially when making investment decisions. It takes a particular mindset and a highly disciplined approach to execute a contrarian investment process successfully.

Know your companies

The other critical component of our approach is bottom-up research.

Fidelity's philosophy is to base investment decisions on company fundamentals such as competitive position, management strength, growth opportunities, valuation and so on.

Overarching trends in the economy (top-down factors) play a supplementary rather than primary role in our investment decisions.

Our investment team spends many thousands of hours meeting company management and speaking to suppliers, competitors and customers in order to build up a picture of the true state of a company's fundamentals.

It is this work that allows us to form a view of the company's future profitability and ultimately whether we consider it an attractive investment for our shareholders.

The benefits of a closed-ended structure

The trust's closed-ended structure also provides some important advantages over open-ended equivalents.

First, the portfolio manager does not have to manage daily inflows and outflows (as occurs in open-ended funds) and therefore is able to focus more directly on researching companies and positioning the portfolio as a direct expression of their investment views.

The closed-ended structure makes us more comfortable using gearing to investThis characteristic also protects the liquidity of the underlying portfolio.

We are not forced into trading decisions by client activity, meaning we are able to take a long-term view and hold positions in companies where liquidity may be constrained.

This is particularly advantageous in the context of our investments in smaller companies, where liquidity can often be a constraining factor.

The closed-ended structure also makes us more comfortable using gearing when the portfolio manager is finding a large number of attractive investment ideas.

Today's opportunities

For a contrarian bottom-up investor in the UK market today, there is a wealth of opportunity on offer.

Investor preferences are currently skewed very heavily towards companies that can provide reliable dividend payments. These stocks have performed well and now trade at high valuations.

As contrarian investors, we are finding that the best opportunities are in areas of the market that investors are more nervous about. Banking stands out as a sector which is cheap, unloved and yet significantly more robust than many realise.

The coming era of chronic uncertainty in the UK is perfect for contrarian stockpickingThe oil sector is also one we see a positive outlook for, despite significant negative sentiment in the market.

Falling prices have led to a reduction in supply growth among US shale companies. This should allow the oil price to stabilise, which would be very positive for a company such as Shell.

More generally, we expect a period of prolonged economic and political uncertainty in the UK to create a favourable environment for contrarian stockpicking.

Among Warren Buffet's many pearls of wisdom, "be fearful when others are greedy, and greedy when others are fearful" stands out as useful in times such as these. 

Important information

The value of investments and the income from them can go down as well as up so you may get back less than you invest. Past performance is not a reliable indicator of future returns.

This trust invests in overseas markets and so the value of investments can be affected by changes in currency exchange rates.

This trust uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations.

This trust invests in a relatively small number of companies and so may carry more risk than trusts that are more diversified. Reference to specific securities or funds should not be construed as a recommendation to buy or sell them, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity.

This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Issued by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, their logos and F symbol are trademarks of FIL Limited.

Matthew Jennings is an Investment Director of Fidelity International.

This article was first published in our special publication 21: Twenty-one years of Interactive Investor. Download your digital copy for free here.

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