If you are going to 'go your own way', you need to be sure of the right direction home. So to be successful as a contrarian investor, you need to do more than simply take a position that runs counter to conventional wisdom: you need to identify inconsistencies in the market's view, usually regarding valuations. Thus value investors tend to be contrarian and vice versa.
At IpsoFacto Investor, our contrarian investment model seeks to identify investment trusts that have an unreasonably wide discount and/or are in unfashionable sectors or regions that we have reason to believe are undervalued.
We then look for the best representative investment trusts, while ensuring that the portfolio is reasonably well diversified.
Our first pick is JPMorgan European Income Trust (JETI), which is priced at 111p, has a discount of 8.0 per cent and yields 4.3 per cent (as at 20 October).
The main reason we like this trust is that, while it looks like a European play (which obviously it is to some extent), its underlying exposure is partly to a set of multinationals whose characteristics are not that different from the companies held by trusts in the UK equity and income sector.
Excluding one outlier, the average discount in this sector is about 1.1 per cent (much narrower than JETI), with a number of trusts trading on a premium.
JETI's top five holdings are Nestlé, Novartis, Roche, Total and Sano - multinationals in the food, healthcare and oil sectors. We have analysed the top 20 holdings and found that in revenue terms the exposure is roughly 60 per cent to companies outside the eurozone and 40 per cent to those in the eurozone. So euro weakness should not affect performance as much as might be expected.
This is not to say that further eurozone angst won't affect this trust. Its price fell sharply in July when the downing of a Malaysian airliner over Ukraine ramped up tension between Russia and the West. From a recent high of around 127p at the end of June, the trust had fallen to 109p by the beginning of August.
On the other hand, should European Central Bank (ECB) president Mario Draghi finally wave the magic wand of fully fledged quantitative easing in the eurozone, JETI should benefit. One point to note is that the trust has recently switched to paying quarterly dividends, so the yield quoted in some newspapers is incorrect.
The second trust choice is BlackRock World Mining (BRWM), priced at 371p. The resources sector has stuttered and spluttered for a while now, but so far has failed to ignite.
blackrock world mining
This trust has had its own particular issues recently, with the writedown of London Mining amounting to 7.7 per cent of NAV and consequent fears over the dividend. Questions are rightly being asked about management, but revenue without any cash from London Mining should be about 18.6p, roughly a 5 per cent yield.
The argument for the sector is not so much that a recovering global economy should be stoking demand (iron ore prices have in fact been particularly weak of late) but that it is about to throw off large amounts of free cash flow. Expensive investments in capacity should come on stream, while the sector is expected to become increasingly cost-conscious.
The trust's top five holdings are Glencore, Rio Tinto, BHP Billiton, First Quantum Minerals and Freeport McMoran, which make up more than 45 per cent of its assets. Specialists in the sector expect dividends to be at least maintained and probably increased, so the trust's revenue should grow, even having taken a hit from London Mining.
Another unloved sector is the financial sector. Here we plump for Polar Capital Global Financials Trust (PCFT), priced at 93p. The recent travails of the sector are well known.
Rising bank fines are worrying, there is uncertainty over bank capital requirements and banks are facing the ECB's asset quality review. However, if the global economy is on the mend and interest rates set to rise, the banking sector should be a beneficiary at some point.
Meanwhile, as with our other choices, the yield on PCFT - expected to be some 3 per cent - should provide compensation. Contrarians need to be courageous, but also patient.
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