It’s never easy to go against the herd, particularly when the flow of news concerning a sector or stock appears to continually disappoint.

Nevertheless, Alex Wright, who manages the Fidelity Special Situations fund and Special Values investment trust, is keen to highlight the potential upside associated with owning a stock that other investors detest – particularly if bad news is more than priced in.

“As a contrarian, I like to invest in stocks which are deeply out of favour with other investors. When the market consensus becomes negatively skewed towards a company, behavioural biases mean investors can be slow to react to positive change, which is what gives us a chance of getting ahead of the market,” he explained.

Investors ‘short’ a stock by betting that its share price will fall from its current level. Wright looks for high shorting interest in a stock and then investigates whether negative sentiment is obscuring investors’ ability to identify positive change.

The table below shows the UK’s most shorted stocks – and highlighted in green are two that Wright currently owns:

Source: Financial Conduct Authority (09/05/19)

“While I might share the market’s negative outlook towards many of these highly shorted companies, in the case of Ultra Electronics and Pearson, I believe that while both companies have had major issues in the past, they have a more positive future ahead of them,” Wright said.

Two hidden gems

For example, investors took fright after FTSE 100 education publisher posted a number of profit warnings between 2015 and 2017, as textbook sales declined and enrolments into education programmes fell.

“This has left many investors believing the company is in a prolonged structural downturn. Today as much as £500m worth of shares are being borrowed by short sellers,” said Wright.

“What I believe they are missing is the enormous investment Pearson has been making into digital education services and the positive effect this could have on the company,” he added.

While this transition could take time, the fund manager believes that patient investors in the business will ultimately be rewarded.

Meanwhile Ultra Electronics,  a FTSE 250-listed defence equipment company, has been shorted by investors who argue that the company has pursued aggressive accounting policies and faces growth challenges.

However, Wright is keen to stress that the company’s latest set of results suggest that these accounting policies can be unwound and organic growth is returning.

“In time, I expect scepticism towards the company to recede, and more attention to be given to the high quality portfolio of defence assets the company owns,” he concluded.