Active managers and their investors must realise that markets are not easy to beat, no matter how often you see irrational behaviour. At Morningstar Investment Management, we‘re long-term investors who base our decisions on valuation. By nature, we are also contrarian, willing to hold unpopular investment positions when supported by our fundamental analysis and valuation.
With this in mind, we can begin to elaborate on our take on the current landscape. Based on a contrarian framework, we find that UK equities are reasonably attractive relative to other major developed equity markets. Particularly, UK managed fund and ETF flows are experiencing meaningful outflows, £3.8 billion in the 12 months to October 2017, at a time when other developed markets continue to experience strong inflows.
This hints that the average investor is beginning to shun the UK equity market, leading to less diversity of ownership as the remaining investors, potentially our contrarian brethren, become more concentrated. Interestingly, a similar theme applies to the British pound, with sterling exposed to negative sentiment stemming from Brexit and thus is seemingly attractive on a contrarian front. Although our confidence on the relative attractiveness of stocks is higher than currencies.
Outside of the UK, we find that positive sentiment has worked its way into many markets, with apparent confidence in global growth, supportive interest rates and low volatility in markets. This is particularly prevalent in the US, although healthcare stocks are one pocket that have not experienced such optimism of late.
European and emerging market equities have also witnessed a material change in popularity, with expectations shifting quickly through 2016 and 2017, no longer representing contrarian opportunities. Looking under the hood though, we continue to witness pockets of unloved assets, with negativity towards emerging Europe, especially Russia, hampering expectations, positioning and sentiment.
Ultimately, we must remind investors that just because something is unpopular, it doesn’t make it a good investment. This is important – a contrarian mindset acts like a screen whose results must be tested with in-depth fundamental and valuation analysis. Unpopular areas of the markets are far from guarantees of success, but we believe they are certainly good places to look for opportunities. In other words, we view contrarian thinking as a means to an end, not as an end itself.
