6 Contrarian Investment Ideas

Despite the market bounce-back of 2023, professional investors still rejected several Morningstar categories. But the most popular funds often don’t stay popular forever. In unpopular corners of the market, you might find funds that are due for an eventual rebound.

Contrarian investing can complement your portfolio with attractive long-term opportunities. Our analysts sifted through categories with the most 2024 outflows to find funds that deserve some love.

Here are six contrarian investment ideas for 2024.

Contrarian investing is the practice of buying assets that are out of favor with the expectation that they will rebound.

Investors tend to buy what’s done well recently and sell what hasn’t. This behavioral bias can cause a feedback loop. Strong inflows drive up stock prices, attracting more return-chasing investors and bidding up prices further.

Contrarian investing bucks market trends in the hope of holding the right investments when market sentiment shifts. The approach may work if other investors overreact to past performance or if riskier assets are priced to compensate investors.

Note that contrarian investing can be risky.  

Areas are often out of favor for a reason, such as a history of underperformance. Contrarian investment ideas may continue to underperform for extended periods. Contrarian investing also doesn’t account for a total portfolio investing strategy. Advisors need to consider any fund picks as a complement to the overall portfolio, investor risk profile, and long-term goals.

Professional investors can use asset flows to find corners of the market where sentiment is changing.

For 30 years, Morningstar’s Buy the Unloved report has put contrarian investing ideas to the test. The initial approach recommended investing equal amounts in the three equity categories with the most outflows from the previous calendar year, holding them for three years, and then repeating the process. In recent years, the analyst team revised their strategy to include more investment categories.

The results have been impressive.

With independent investment data, investors can turn up the most promising funds in a rejected category of equity, fixed-income, or allocation funds.

A quick note: for timeliness, this approach was calculated with flows data through November 2023 and does not account for December flows.

Now let's get into the specifics.

Large value

Despite high inflows over the last two years, the large value category saw the greatest absolute dollar outflows in 2023. These portfolios primarily invest in U.S. companies in the top 70% of the capitalization of the equity market. Value is defined based on low valuations and slow growth.

Large growth

The large-growth Morningstar Category has seen some of the highest outflows in 22 of the last 100 years. These portfolios invest in big U.S. companies that are projected to grow faster than other large-cap stocks. Mostly, these funds focus on companies in rapidly expanding industries.

Health sector funds

Health funds have struggled over the last two years. These focus on the medical and healthcare industries, investing in everything from pharmaceutical and medical device makers to HMOs, hospitals, and nursing homes. Some concentrate on one segment, such as service providers or biotechnology firms.

Bank loan funds

These mutual funds or ETFs primarily invest in floating-rate bank loans. The portfolios aim to compensate for higher credit risk with high-interest payments that usually float above a common short-term benchmark.

Bank loan portfolios can come with implementation challenges and limited upside potential due to the lack of call protection. With almost no preconditions, bank loans can be refinanced at or near par to cut interest costs.

Muni national short bonds

These short-term bonds are issued by state and local governments from across the country. Governments use the revenue to fund public projects, and bondholders usually don’t have to pay federal taxes on income. To lower risk, these portfolios spread assets across many states and sectors.

Muni national short bonds have durations of less than 4.5 years or average maturities of less than five years. Because of their shorter duration, they are less vulnerable to changes in interest rates.

Only one category group, fixed income, had inflows in 2023. Investors chased higher interest rates and rebalanced surging equity positions, resulting in a $395 billion inflow to category funds.

These were the most popular categories according to our buy-the-unloved approach.

• Large blend. These portfolios represent the overall U.S. stock market in size, growth rates, and price. They tend to invest across industries.
• Foreign large blend. Most of these portfolios divide assets between at least a dozen or more developed markets, with typically less than 20% of assets in U.S. stocks.
• Japan stock. The Japanese stock market is one of the largest in the world, so these portfolios’ holdings vary significantly. Some portfolios concentrate on Japan’s larger companies, while others focus on smaller firms.
• Long government bonds. These portfolios have at least 90% of bold holdings invested in government-backed bonds, which minimizes credit risk. They usually have durations of more than six years.
• Derivative income. These nontraditional equity portfolios usually use an options overlay to generate income while maintaining significant exposure to equity market risk.
• Intermediate core bond. These funds invest primarily in investment-grade U.S. fixed-income issues and hold less than 5% in below-investment-grade exposures.

Value investing focuses on finding undervalued assets and seeks to buy them at a discount. Ratings like the Morningstar fair value estimate can indicate opportunities that are undervalued by the market. Contrarian investing often follows outflows, which don’t guarantee that a fund will be cheaper. Heading in the opposite direction of flows, however, can turn up potential investments that the crowd has underestimated.

Both approaches require patience, but contrarian investing especially demands the right time horizon.

With investment research tools, advisors can investment types side-by-side to find an option that makes the most sense as a complement to an overall portfolio.

1. Filter by one of the six categories above to isolate contrarian investments.
2. Screen by the Morningstar Medalist Rating.The rating combines analyst thinking and quantitative techniques into one forward-looking view on strategies. It can provide an initial assessment as a jumping-off point.
3. Filter by performance history. Look for funds with past total returns in the top percentile of the category. Use the Sharpe ratio to assess historical risk-adjusted returns.
4. Add additional criteria like the Portfolio Risk Score, expense ratio, or fund size to find investments that meet portfolio objectives.