The out-of-favour funds experts are sticking with

Financial markets have a whiff of complacency. Indices hit new highs over the summer, in apparent defiance of tariff turmoil, geopolitical tensions and economic uncertainty. Nervous investors may want to try some “anti-complacency” options – areas that remained unloved even as markets soared.

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In reality, a lot of investor complacency is confined to the US stock market and the mega-cap technology companies in particular. These have continued to thrive despite the very real threat posed to US multinational companies from tariffs. However, cracks have been appearing. NVIDIA Corp (NASDAQ:NVDA)’s strong earnings were greeted with a shrug by investors and a number of the Magnificent Seven – notably Apple Inc (NASDAQ:AAPL) and Tesla Inc (NASDAQ:TSLA) - have been wobblier since the start of the year.

The problem is that these areas often form a significant chunk of investor portfolios. Richard Weiss, chief investment officer of multi-asset strategies at American Century Investment, says the concentration of the S&P 500 index is as high as it has ever been, with the top 10 stocks now representing roughly 40% of the index.

The weakness of the US dollar is another reason to look beyond these highly valued technology names. The US currency has been weak since the start of the year. It briefly staged a revival in late July, but sunk again after Donald Trump’s interference in the Federal Reserve. This makes the calculation for UK investors more difficult – they are buying an expensive market, without the tailwind of US dollar strength.

Anti-complacency trade

What would an anti-complacency trade look like? The dominance of the US stock markets has meant that almost everywhere else looks at least decent value. The UK, for example, has been very strong since the start of the year, but has almost 10 years of sluggish performance to recover and still looks cheap on almost all objective metrics. Europe, emerging markets, and much of Asia, have all struggled as the mega-cap technology trade has crowded out other opportunities.

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Regionally, Rob Burdett at Nedgroup Investments, believes emerging markets are a fertile hunting ground for investors. The MSCI Emerging Markets index has outpaced the MSCI World Index by around 6% for the year to date (to the end of August). The revival of China appears to have galvanised investment across emerging markets. They have also benefited from a shift in thinking on the relative risks of emerging markets versus developed markets – if the US government is going to interfere with the central bank, pursue unorthodox monetary policy and upend international trade, why should emerging markets command a significant risk premium?

Burdett adds: “These look cheap against their own history and internationally. They usually do well when the dollar is weak as well.” They have been out of favour for a long time. Burdett says: “Geopolitical instability hasn’t helped and China, being the largest emerging market, has been struggling until recently.” However, this has changed as the government has shown greater willingness to support the Chinese economy and markets. JPMorgan Emerging Markets Ord (LSE:JMG) and Utilico Emerging Markets Ord (LSE:UEM) are both on the ii Super 60 list of investment ideas.

Healthcare and biotechnology

There are also a number of individual sectors that stand out as good value. Healthcare has struggled. The MSCI Global Healthcare index is down 10.9% over the past year, trailing the MSCI World by around 27%.

In the longer term, it is supported by strong structural factors, with ageing populations across many developed economies raising healthcare needs. However, it has suffered from uncertainty over US drug pricing, changes at the US Food and Drug Administration (FDA) and US President Donald Trump’s capricious hiring of a vaccine sceptic Robert F. Kennedy Junior, as US health secretary.

Burdett says: “Healthcare looks out of favour to a greater degree than is perhaps warranted, especially providers of insured care.  Berkshire Hathaway Inc Class B (NYSE:BRK.B) recently announced a new large stake in UnitedHealth Group Inc (NYSE:UNH) in the US, which could be the reason sentiment bottoms out. Their shares jumped 15% on the day of the announcement. It is a key holding for Andy Headley of the Veritas Global Focus fund with whom we are invested.”

Ian Rees, head of multi-manager investment at Premier Miton, highlights biotechnology in particular: “If I said there was a high-growth sector, driven by a wave of technology innovation, with real societal impact, you’d probably assume I was talking about artificial intelligence (AI), but these are all the attributes of biotechnology.”

The key difference is that biotechnology is trading at all-time lows rather than all-time highs after a very difficult run. The average biotechnology and healthcare investment trust is down over 17% over five years.  

Rees says there has been a lot of focus on personnel changes at the FDA, but biotechnology is one step removed. “Trump’s focus is on reducing drugs pricing and promoting US pharma. Pharmaceutical companies tend to do the distribution. Biotechnology is generally the innovation that creates the product, which insulates it from the direct impact of tariffs”.

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Biotechnology is benefiting from increasing M&A activity – Sanofi SA (EURONEXT:SAN) paid a 300% premium to the market price when it bought Vigil Neuroscience, while Novartis AG Registered Shares (SIX:NOVN) paid a 290% premium to acquire Regulus Therapeutics. Rees says the greatest issue for biotechnology is interest rates. It is a growth asset with cash flows some time into the future. Companies tend to borrow through their discovery phase, with a cash pay off later down the line. Therefore, he believes falling interest rates may be a positive catalyst for the sector.

He likes Polar Capital Biotechnology fund, which, he says, has managed to navigate the cycle well. He also likes the iShares Nasdaq US Biotech ETF USD Acc GBP (LSE:BTEK), which gives exposure to core biotechnology. He also sees opportunities among the investment trusts, many of which are still trading at a discount. These include International Biotechnology Ord (LSE:IBT), which offers conventional exposure, and RTW Biotech Opportunities Ord (LSE:RTW), which targets early stage biotechnology companies.

It is worth noting that investors don’t necessarily need to avoid the US and/or technology in their hunt for value across global stock markets. David Coombs, head of multi-asset investment at Rathbones, says there’s real value if investors look beyond the conventional AI story. He sees value in software companies, for example.

Coombs notes: “These have underperformed as the market has worried over the amount they need to spend on providing AI solutions and AI disruption.” He points to companies such as Salesforce Inc (NYSE:CRM) and SAP SE (XETRA:SAP) which are trading at a fraction of the AI-focused mega-caps. However, he admits investors need to be brave as there isn’t a lot of visibility on earnings.

Financials have been very strong, up 28% over the past year, but Coombs still sees value in companies with proprietary data sets, such as some of the large exchanges – London Stock Exchange Group (LSE:LSEG), or the Chicago Mercantile Exchange, known as CME Group Inc Class A (NASDAQ:CME). The LSE owns Refinitiv, for example, which gives it valuable data. RELX (LSE:REL) has a similar story, but has been very week. “These data owners will be the winners from AI,” he says.

Weak spots across US markets

Weiss says there have been a number of persistent weak spots across US markets, including real estate, energy stocks, healthcare and small-cap equities. If investors want to stick with US equities, these would be the areas to look. He adds: “We believe that the real estate sector may be primed for a breakout. Chief among the reasons for this is the fact that the Federal Reserve is at a turning point in monetary policy and likely to being reducing rates.”

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Small-caps have underperformed, but could also benefit from a reduction in interest rates. The sector make-up has also been important says Weiss: “The Russell 2000 index is much more heavily weighted in unpopular, lagging sectors such as healthcare and consumer discretionary issues. While the S&P 500 is more heavily skewed towards tech, telecommunications, and financials - which have done well this year. If our outlook for interest rates and real estate is correct, the Russell Index should be showing much improved relative performance throughout the end of this year.” The Artemis US Smaller Companies fund is on the ii Super 60 list.

The dominance of the S&P 500 and the mega-caps in particular has crowded out other opportunities across the world, and in other sectors. This has left plenty of value elsewhere. These are the anti-complacency options, with lower expectations and lower prices.