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SKAGEN Focus: Contrarian investors on a profitable path

It is not easy to be a contrarian investor. You need to be bold, patient, and able to interpret, use and invest into the contrarian phenomena that occur and create inefficiencies in global equity markets. These investment situations are currently most prevalent in small and mid-cap stocks, which explains our fund’s natural investment focus.

At its core, the art of a being contrarian is about finding investment cases that are undiscovered today but at some point in the future – within 2-3 years in our case – will be sought after by others, allowing us to exit with a lucrative return.

As value investors, we make investments when we find a substantial discrepancy between current market value and our fair value estimate, based on normalised earnings power. In our experience, outstanding investment decisions often initially feel very uncomfortable. An investment team that has a natural instinct to go against the crowd is crucial for success. Patience is also required, usually during the frustrating “Waiting-for-Godot” moment of most investment cases when catalysts remain elusive and uncertainty prevails but the position size still needs to be increased.

Our portfolio of assets that we believe to be significantly undervalued will show outstanding results versus the global equity market at times, but inferior ones at others. Value creation over time is rarely linear – as the saying goes, “you're never as good as people think you are when you win; and you're never as bad as people think when you lose”.

During periods of significant disruption and transition, the equity market tends to exaggerate the future financial impact of change, particularly on company valuations. The dot com boom of 1999-2000, the emergence of Big Tech in the last decade and the current AI-related complex are good examples of this. All these periods have undeniably produced outstanding companies, but they will inevitably go “ex-growth” at some point and valuations will compress. With several US tech companies recently announcing aggressive share buy-back and cost-cutting programs, there are signs that this process is already underway among the current favourites.

A cataclysmic investment environment

Over the last five years, the global equity market has endured several cataclysmic episodes, such as the last whisper of the QE era, the COVID pandemic and subsequent inflation, a war in Europe resulting in a normalisation of interest rates, and AI mania. These events have produced a volatile investment environment that has created very lucrative investment opportunities for those with a broad perspective, particularly contrarian and value-based investors like us. Since late last year, however, the market’s narrow focus has returned, this time centred on AI-related stocks and elevated through global passive equity mandates, driving global equity market concentration to previously unseen levels.

As always, these types of extreme market environments uncover very interesting investment opportunities in the ignored and unexplored parts of the market. We believe that in the coming three-to-five years when the current narrow global equity market exhausts itself, investors will recognise the value proposition in below-the-radar small and mid-caps globally.  

Our latest contrarian pearls

In our global search for contrarian and significantly undervalued assets, we often encounter a large degree of investor scepticism and depressed sentiment. The Italian-based truck maker Iveco, which once traded at a very depressed multiple reflecting a negative outlook, has climbed more than 70 percent in 2024 as the market has discovered its abnormal valuation. The stock is one of our strongest winners this year, contributing solidly to fund performance. The position has been sold down substantially after approaching our price target, reflecting our disciplined investment process and position sizing approach.

We have also discovered very interesting opportunities in the South Korean equity market, which is undergoing substantial transformation. We recently added undervalued construction company DL E&C, which trades below its core normalised operating income, and regional bank DGB Financial, valued at only three times earnings power.

Another recent addition is Japanese regional bank, Hyakugo Bank, which was valued at 0.3 times book value and had a market cap in line with its unrealized gains on its non-core equity portfolio when we invested. Finally, despite facing severe difficulties in finding our required deep discounts in the US equity market, we have discovered an ignored specialty insurer with very solid fundamentals and low valuation in the form of Old Republic. Very few analysts cover the USD 8 billion market cap stock which trades at a vast discount to domestic peers with similar fundamentals.

May we introduce “The Magnificent Gap”?

We can visualise the current intriguing investment opportunity through the large discount in valuation multiples between global small/mid-caps versus large/mega caps. We have previously labelled this the “Magnificent Gap”, which we believe offers a far more interesting focus than the “Magnificent Seven”. It can be summarized as follows:

  • European small caps trade at a discount to large caps last seen during the depths of the Global Financial Crisis: 


  • The valuation gap between the Magnificent 7 and global small caps remains huge: 


  • Global small and mid-caps continue to trade at historic lows relative to large caps:


  • On a P/B basis the discount of global small caps versus large caps continues to widen:


With smaller companies’ earnings and book value multiples now at their lowest versus larger ones since MSCI started to measure these ratios, we would not be surprised to see a mean reversion in their relative valuations, leading to a closing of The Magnificent Gap.

Deviating from the crowd can produce outstanding results

Our recent awards demonstrate how parting from the crowd can produce outstanding results over time. This year we have won Lipper awards for best global small/mid-cap fund over five years in Germany and the Nordics, building on our success in 2023 when we won similar awards in the UK and Netherlands over three years. However, we believe the best is still to come as the recent equity rally broadens into ignored small and mid-cap stocks. It’s time to mine the gap.

Source data: SKAGEN and Bloomberg (as of 31 March 2024)

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