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3 Investing Ideas for Contrarians

Those with the right constitution may find opportunity in these pockets of the market.

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Stan Lee, legendary creator of countless Marvel comic book superheroes, didn't follow the crowd. He was unconventional. Unlike other comic book heroes, Lee's protagonists--Spiderman, Iron Man, and the Incredible Hulk, among them--had flaws. Lee's heroes overcame their flaws to do great things. 

When it comes to investing, few of us are like Stan Lee. It's tough to go against the crowd when your money's on the line. Herding--or following said crowd--is much easier to do. Buying what others aren't, or when others aren't, takes a special constitution: the constitution of a contrarian.

There's no single lens through which contrarians operate, and there's no one way to be contrary. Some short stocks that they deem overvalued. Others, like those in Morningstar's manager research group, use fund flows as a contrarian indicator; their annual study suggests buying unpopular categories and selling popular ones.

In homage to Stan Lee and for contrarian investors everywhere, today we're sharing some of Morningstar's best ideas from areas of the market that have been out of favor this year. Specifically, we've isolated Morningstar Categories and sectors with the worst year-to-date returns at the end of the third quarter and then named some of our analysts' favorite picks in each.

Of course, these contrarian ideas aren't for everyone, and they shouldn't dominate a portfolio. They're best at the fringes--kind of like Hawkeye.

Idea 1: Small- and Mid-Cap Growth Funds

Small and mid-cap growth funds finished the third quarter up less than 10% for the year to date. While those returns sound good in isolation, they lag the gains of large-cap and value strategies by a healthy margin in 2021.

Though both value and growth strategies have done well during different periods this year, September wasn't particularly kind to growth strategies. And large-cap funds across the board posted better results than their smaller-focused peers.

Dig deeper: A Quarter in the Red 

Granted, growth strategies of all market capitalizations still lead their value-focused cousins for the trailing three-, five-, and 10-year periods, and therefore may not seem all that contrarian to many investors. Those with the interest and fortitude to add a domestic mid- or small-growth fund to their portfolios, though, can begin their search by narrowing the field to Morningstar's top-rated exchange-traded funds and mutual funds in those categories. Note that some of the funds on this list are not accepting money from new investors, only current ones. Be sure to check a fund's status on its report page.

Idea 2: Utilities Stocks

The Morningstar US Utilities Index was up just 3.5% for the year through September, making utilities the worst-performing sector this year. We don't expect utilities to start outperforming anytime soon, either, says sector strategist Travis Miller. Why? For starters, valuations are high relative to historical levels. And inflation poses a sizable near-term threat.

"The recent spike in inflation is already leading some utilities to adjust their spending plans, leery that regulators won't allow them to pass along higher raw material costs," observes Miller. "During the last period of higher, more volatile inflation in the 1990s and early 2000s, utilities regularly underperformed when inflation was rising."

Dig deeper: Inflation a Big Obstacle for Utilities

That being said, Miller admits that most utilities have strong balance sheets and dividend-growth potential--and the dividend yield that utilities offer is still attractive relative to bonds. Plus, utilities will play a significant role in the renewable energy efforts of policymakers.

Nine utilities with narrow or wide Morningstar Economic Moat Ratings are now undervalued, according to our metrics.

Those who'd rather invest in a larger pool of utilities stocks have a couple of highly rated funds to research further.

Idea 3: China

The third quarter was a tough one for Chinese stocks. Regulatory crackdowns by the Chinese government on technology and consumer companies, slowing growth, and new disclosure requirements from the U.S. Securities and Exchange Commission have hammered stocks: The Morningstar China Equity Index was down 17% for the year to date through September.

What's Morningstar's take? "Considering the series of recent regulatory actions from the Chinese government, we don't think that regulatory risks for Chinese companies are over," explains Morningstar's chief U.S. markets strategist Dave Sekera. However, we've re-evaluated the fair values estimates of the companies we cover and don't think further regulatory changes will have additional impact on our long-term valuations.

Dig deeper: 9 Undervalued Chinese Stocks That Have Been Oversold

The Chinese stocks below are all listed on U.S. exchanges and are undervalued according to our metrics.

For those who would rather get exposure to Chinese stocks via a fund, here are some of our top-rated options to research further.

Disclosure: Morningstar, Inc. licenses indexes to financial institutions as the tracking indexes for investable products, such as exchange-traded funds, sponsored by the financial institution. The license fee for such use is paid by the sponsoring financial institution based mainly on the total assets of the investable product. Neither Morningstar, Inc. nor its investment management division markets, sells, or makes any representations regarding the advisability of investing in any investable product that tracks a Morningstar index.

Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.