Con­trar­ian calls from two canny trusts

Ex­pert stock­pick­ers show how you can gain by go­ing against the grain

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Con­trar­ian in­vestors look for com­pa­nies whose po­ten­tial for share price growth or re­cov­ery has been over­looked by the mar­ket. This style re­quires nerves of steel; hu­mans have evolved to like to be­long to a group or feel a part of some­thing big­ger, so tak­ing a con­trar­ian stance is un­com­fort­able and you have to be pa­tient as the in­vest­ment case un­folds.

For this rea­son it can be better to adopt a con­trar­ian ap­proach through an ex­pe­ri­enced fund man­ager. THE SCOT­TISH


One well-es­tab­lished fund with a con­trar­ian ap­proach is The Scot­tish In­vest­ment Trust (SCIN), cur­rently trad­ing at a 9.1% dis­count to net as­set value.

In­vest­ing glob­ally with the aim of achiev­ing cap­i­tal ap­pre­ci­a­tion and in­fla­tion-beat­ing div­i­dend growth, the trust’s fourstrong man­age­ment team led by Alas­dair McKin­non uses be­havioural fi­nance tech­niques to ex­ploit in­vestors’ ten­dency to ‘fol­low the crowd’. By fo­cus­ing on stocks that are very unloved, those with op­er­a­tional im­prove­ments that have been over­looked, and more pop­u­lar stocks that can con­tinue to do better, the man­agers build in a mar­gin of safety.

McKin­non has made two con­trar­ian calls in the unloved re­tail sec­tor, where head­winds in­clude fall­ing con­sumer spend­ing, ris­ing costs from ster­ling’s weak­ness, a po­ten­tially re­duced supply of work­ers post-Brexit and the im­pact of rapid struc­tural change.


‘E-com­merce is putting margins un­der pres­sure, and many re­tail­ers are find­ing that much of their floor space is re­dun­dant,’ says McKin­non. ‘And many tra­di­tional high-street stal­warts are com­ing un­der fire from dis­count chains. We shouldn’t be sur­prised, then, that many in­vestors pre­fer to look else­where.’

The Scot­tish In­vest­ment Trust doesn’t see this as the right ap­proach. ‘We’re con­trar­ian to our core and be­lieve that the best op­por­tu­ni­ties arise when the mar­ket over­re­acts. It’s then that the “wis­dom of the crowd” gives way to herd in­stinct and group­think.’ McKin­non be­lieves in­vestors are over­look­ing the po­ten­tial for the Bank of Eng­land and the gov­ern­ment to take some of the pres­sure off con­sumers.

The as­tute stock­picker adds ‘it is also pos­si­ble that the Brexit ne­go­ti­a­tions will be smoother than ex­pected. De­spite all noise from both sides, a prag­matic ap­proach may well pre­vail once the process is in full swing. Sim­i­larly, we think that con­cerns about the UK con­sumer may be over­cooked.

‘Con­sumer spend­ing could be curbed by some of the po­ten­tial Brexit out­comes. But so far, con­sumers have been car­ry­ing on as normal. Fol­low­ing the Bank of Eng­land’s in­ter­est-rate cut last sum­mer, cheaper mort­gages and loans have en­cour­aged con­sumers to bor­row and spend. With in­ter­est rates likely to re­main low, the com­bi­na­tion of low un­em­ploy­ment and higher wages would help to keep the re­tail sec­tor on a steady foot­ing as it faces up to its struc­tural chal­lenges.’

McKin­non sees ‘the most cur­rent op­por­tu­ni­ties in UK re­tail as “ugly duck­lings” – unloved shares that most in­vestors shun. Be­cause their op­er­at­ing per­for­mance has been poor for some time, their shares are very much out of favour. But we see po­ten­tial for them to defy the mar­ket’s ex­pec­ta­tions and turn their cir­cum­stances around. And while we wait for our ugly duck­lings to be­come swans, most of them of­fer higher-thanaver­age div­i­dend yields.’ Marks & Spencer (MKS) ‘is a clas­sic “ugly duck­ling”.

Its cloth­ing di­vi­sion has been strug­gling for some time. But un­der CEO Steve Rowe, it has be­gun to turn things round through a better pricing strat­egy. Mean­while, the company’s food di­vi­sion is still mar­ket lead­ing, and its in­vest­ments in IT and in­fra­struc­ture are creating a multi-chan­nel of­fer­ing that can suc­ceed in to­day’s digital en­vi­ron­ment. And while we wait for its shares to re­flect this, Marks & Spencer of­fers a sus­tain­able div­i­dend yield of 5.5% – and 7% with this year’s spe­cial div­i­dend.’

‘Another “ugly duck­ling” is Tesco (TSCO), where CEO Dave Lewis is aim­ing to re­build prof­itabil­ity, re­store mar­ket share and re­gain the trust of con­sumers and in­vestors. And he is mak­ing pos­i­tive progress. Lewis is fo­cus­ing on growth in the core UK busi­ness and has sold off pe­riph­eral as­sets at home and abroad.’ The ac­qui­si­tion of food whole­saler Booker is de­signed to se­cure Tesco’s po­si­tion as the UK’s largest food busi­ness, better pricing and an en­hanced cus­tomer of­fer­ing have led to im­proved same-store sales. ‘Mean­while, a £1.5bn cost­cut­ting pro­gramme should sup­port margins, which are cur­rently the low­est among UK su­per­mar­kets,’ adds McKin­non.


Alex Wright, man­ager of Fidelity

Spe­cial Val­ues (FSV) , fol­lows a value-con­trar­ian phi­los­o­phy cen­tred around buy­ing unloved com­pa­nies in out of favour sec­tors and hold­ing them un­til their po­ten­tial value is

recog­nised by the wider mar­ket. Wright in­vests in com­pa­nies with ex­cep­tion­ally cheap val­u­a­tions or some kind of as­set that should pre­vent the share price drop­ping be­low a cer­tain level, such as in­ven­tory or in­tel­lec­tual prop­erty, which gives him a mar­gin of safety.

Like McKin­non, Wright is will­ing to put money to work in sec­tors that di­vide opin­ion among in­vestors and has in­creased the trust’s al­lo­ca­tion to banks with the ad­di­tion of two new ideas. As Matthew Jen­nings, in­vest­ment direc­tor for UK eq­ui­ties, Fidelity In­ter­na­tional, ex­plains:

‘While IPOs do not usu­ally meet our con­trar­ian cri­te­ria, the re­cent IPO of Al­lied Ir­ish

Banks (AIB) is some­thing of an ex­cep­tion. AIB and Bank of Ire­land (BoI) have around 60% com­bined mar­ket share each in the Repub­lic of Ire­land, creating a very at­trac­tive in­dus­try struc­ture in an econ­omy which has seen a strong re­cov­ery and could out­per­form other Euro­pean economies for years to come. How­ever, un­like BoI, AIB has a low qual­ity loan book - around 16% in bad loans com­pared to 5% at BoI. This makes the mar­ket wary of the company, and un­doubt­edly makes it more ex­posed to the macroe­co­nomic sit­u­a­tion in Ire­land.’

The pos­i­tive news is the bank ‘is ex­tremely well cap­i­talised, with a 16% Core Tier 1 Ra­tio, which gives it a good deal of pro­tec­tion against fur­ther write­downs. If man­age­ment is able to con­tinue re­duc­ing the bank’s ex­po­sure to bad loans, it will free up large amounts of cap­i­tal for dis­tri­bu­tion to share­hold­ers.’

Another new po­si­tion for Fidelity Spe­cial Val­ues is Royal

Bank of Scot­land (RBS). ‘Up un­til now, Alex has avoided RBS in pref­er­ence of other banks where the re­cov­ery is more ad­vanced,’ says Jen­nings. ‘How­ever, an at­trac­tive bal­ance of risk and re­ward is now emerg­ing. There is con­sid­er­able un­cer­tainty hang­ing over the company as it awaits a de­ci­sion from the US Depart­ment of Jus­tice re­gard­ing the size of the fine RBS faces, mean­ing most in­vestors have pre­ferred to in­vest in banks with fewer un­cer­tain­ties. If the fine is at the up­per end of ex­pec­ta­tions, RBS re­mains well cap­i­talised

- if it is at the lower end, it is

very well cap­i­talised, and in a strong po­si­tion to be­gin the process of cap­i­tal dis­tri­bu­tion to share­hold­ers and re­sume div­i­dend pay­ments. RBS has been thor­ough and ar­du­ous process of portfolio re­struc­tur­ing and in­vest­ment bank down­siz­ing, but we are now be­gin­ning to glimpse the light at the end of the tun­nel.’ (JC)

Alex Wright, man­ager of Fidelity Spe­cial Val­ues

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