Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

The shift in investor sentiment towards so-called value shares has been dramatic. The prospect of an early vaccine has triggered a rotation from big, defensive, high-growth shares to smaller, more cyclical shares that require a pick-up in economic activity in order to flourish.

Last week’s market movements were extreme, but the pattern is long-standing. Throughout the market rally, growth shares have led the charge, but value shares have outperformed whenever the news-flow has pointed towards an early return to normal.

The case for a continued rotation is made even stronger thanks to the now yawning valuation gap between the two types of share. Growth shares deserve to be more highly rated because they are experiencing faster improvements in earnings. However, the disparity has reached an historically extreme level.

Put the two factors together - positive vaccine news-flow and valuations - and it is not hard to see why many investors are starting to position themselves for a watershed shift in leadership. Those with longer memories are harking back to the end of the dot.com bubble in 2000 when a similar rotation took place.

Which begs the question: what is the best way to capitalise on this change in sentiment? The instinctive reaction may be to simply buy into the sectors where valuations are the most beaten-up, what’s sometimes called ‘deep value’.

Instinctively right, this approach might just be swapping one kind of risk for another. You might eliminate the valuation risk by going for the market’s cheapest shares in this way. But you are probably introducing a whole new set of structural challenges into your portfolio. Some sectors have been permanently damaged by the ongoing trends which the pandemic has magnified.

Matt Siddle, a manager of European funds here at Fidelity, says he prefers to look for companies which have a decent earnings trajectory despite everything that’s going on in the economy as a whole but whose valuations have fallen to unusually low levels by association with the rest of their out-of-favour peer groups.

It’s worth pointing out that this has not been a successful strategy of late. The market has rewarded the most expensive companies and turned its back on businesses with solid fundamentals - that is to say good growth at a reasonable or cheap price.

For those investors who remember the market in 2000, this situation looks all too familiar. And many will be hoping that it resolves itself in the same way as it did 20 years ago. The popular technology stocks on sky-high ratings fell sharply while companies languishing on rock-bottom ratings because they were seen as dull, old-economy businesses suddenly looked like safe havens.

Of course, no-one knows when or if the market will repeat this style rotation. But the valuation extremes do stack the odds in favour of a change in leadership next year.

The Select 50 list is deliberately constructed to include both growth and value styles so that investors can find a high-quality investment to suit all market conditions.

In the UK category, the most obvious value play is the Fidelity Special Situations Fund. If you look at its performance figures (check out the factsheet here), you can see very clearly how the style has underperformed over five, three and one years but out-paced the market over one, three and six months. It is riding the value wave.

In the European category, the Fidelity European Growth Fund, which is managed by Matt Siddle, has also out-performed over one and three months despite lagging the market in the medium term as its ‘quality at a reasonable price’ philosophy has struggled.

For true contrarians, the Man GLG Japan CoreAlpha Fund might be worth a look. This value-focused fund has been badly out of favour during the pandemic but, like the other two funds mentioned here, has out-performed more recently.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. The Fidelity Special Situations Fund and Fidelity European Growth Fund use financial derivative instruments for investment purposes, which may expose the funds to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Currency hedging is also used in the funds to substantially reduce the effect of currency exchange rate fluctuations on undesired currency exposures. There can be no assurance that the currency hedging employed will be successful. Hedging also has the effect of limiting the potential for currency gains to be made. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics Covered:

Volatility; UK; Japan; Europe; Active investing

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