Product Showcase: Calm in the chaos

Sharemarket crashes and their inevitable recovery are well-charted, but no one really talks about what happens in between.

Who are the investors caught in the crash, and who are the ones that capture the most gains on the way up?

In that space between sell-off and recovery lies the under-explored story of contrarian investing.

It's the one where every decision demands deep pockets, mental stamina and a sturdy stomach.

If the sharemarket was a dish, market volatility would be on the daily menu.

That's why contrarian investment expert Paul Fairbrother, institutional portfolio manager at MFS Investment Management, doesn't fear volatility, he eats it for breakfast.

As Fairbrother puts it, "Our investment philosophy is to always run into the 'burning building' when people are coming out and be that contrarian in the room that's going in the opposite direction."

That burning building could be a market bubble and bust, a global pandemic or a geopolitical crisis . In recent months, the market is catching fire from supply chain disruptions.

At a company level, Fairbrother would be drawn to large companies, often household brands, in the thick of controversy, like a profit warning or a management restructure.

It's in this space where others fear to tread that Fairbrother - through the MFS Global Contrarian Equity Fund - gets down to work.

Margin of safety

Before the sharemarket became a sophisticated game of dots on a graph and instant trading, it was a simple case of investing in good companies.

It's the wide margin between what a good company should be worth and how their valuation gets caught in the general wash that spurred MFS to launch its contrarian strategy in 2016.

A year prior, the Chinese market bubble had burst in the worst way possible, plunging 43% in a few months and dragging the rest of the world with it. No investment book could prepare investors for such a scale of market dislocation.

But to MFS, the numbers may be different, but they've seen it all before. Founded in 1924, MFS is one of the longest-running asset managers in the world, and they've lived through the dotcom bust, the rise of hedge funds, the proliferation of quant strategies and, more recently, indexed investing.

That experience shaped their core belief that markets will always be driven by fear and greed, which led to their contrarian strategy that systematically exploits those emotional overreactions and turns them into portfolio returns.

That system is underpinned by four investment pillars.

First, the fund only buys stocks on cheap valuations because that reduces their reliance on uncertain forecasts.

Second, they stick with a bottom-up, not macro-driven, approach, which reduces their vulnerability to rate forecasts.

Third, regardless of the share price, the company's balance sheet should survive a Global Financial Crisis (GFC) stress test.

Finally, Fairbrother says that a contrarian strategy has to be 'emotionally resilient', meaning you can't be attached to any one idea and you need to hold your nerve no matter how the markets are behaving around you.

All this to say the fund has the muscle memory of a 102-year-old fund manager and understands what market guardrails should look like.

"We work very hard on what we call a margin of safety, particularly around our downside risk modelling, so we can get the odds stacked more in our favour."

Investing in controversy

Asked what stocks the fund invests in, Fairbrother said that there have been various types over the past 10 years, but three areas stick out the most.

"The first would be in the deep value space where there's perhaps a big risk arbitrage between the upside and downside on the stock. With a capital cycle lens of looking through those companies, particularly when capital is coming out of an industry, it's quite good for the incumbent players that are left."

Then there are the quality compounders or distrusted growth companies.

"These are good companies that fall on hard times. That's exploiting the human-nature element to this, where we're prone to extrapolate news, and when it's good, you tend to get too optimistic and overprice a stock, and when it's bad, people get too pessimistic, assume the news flow is going to stay bad and eventually underprice the stock."

The rich pickings for the fund are the structuring plays.

"Often with good companies, they make mistakes. There are self-inflicted wounds like doing an M&A that goes wrong or they change management and it doesn't work out," said Fairbrother.

Because they have a lot of knowledge on that company, the fund can then make a decision to buy and make money as the shares start to reflect not the controversy, but the company's reality.

No room for a benchmark

In a world inundated with strategies set against a benchmark, the MFS Global Contrarian Equity Fund has a very concentrated portfolio of 30 stocks with a focus on absolute returns.

"We're aware of the benchmark, but we don't try and build a portfolio around it. We want an idiosyncratic portfolio of risks that are not slaves to the bench, and that's the contrarian instinct in us."

"I put the question back to the investor and say, 'Do you want to own the stock or the industry when it's three per cent of the benchmark or when it's 30 per cent?'"

He argues, "If a stock is already 30% of the bench, everyone's already in there. They [everybody] own that stock. We want to own the unknown stock that's not in the bench."

Without the need to hug a benchmark, Fairbrother has more control - but also more at stake - in his portfolio.

Here's the best bit though. Both traditional and contrarian investors get blindsided by market shocks in equal measure.

While the traditional investor takes whatever the market serves, the contrarian fund manager Fairbrother orders his usual: bad news, turbulence and a generous heap of conviction.