Fidelity Special Situations saw strong performance in 2012 after a poor 2011 had piled pressure on Shah. The manager says this success is the result of a change in market behaviour, which now favours his contrarian style. Diminishing macro-economic headwinds mean that the market is now focusing on fundamentals, which favours value investors, he explains.
"Stock correlations were at an elevated level at the end of 2011, the drivers were common risk factors such as the eurozone crisis," said Shah (pictured).
"For me, that was the time of maximum opportunity, but since then correlations are coming down, although there is more to go in that respect."
"We are returning to a bottom-up stockpickers market. The value style of investing was at an extreme bad point at the end of 2011 and I hope we were able to take advantage of the opportunities and we will see the benefit in the coming years."
Data from FE Analytics shows that value stocks have performed much more strongly than growth stocks over the last few months of 2011.
Performance of indices over 3yrs
Source: FE Analytics
The MSCI United Kingdom Value index of stocks with a value slant has grown almost 40 per cent since August 2011, while the MSCI United Kingdom Growth index is up 27 per cent.
Shah expects this outperformance to continue and has already seen a significant rebound in a number of his recovery stocks.
Lloyds was the best-performing stock on the UK market last year, up 110.93 per cent since January 2012, according to data from FE Analytics.
Performance of stock since Jan 2012
Source: FE Analytics
However, Shah says the story is not finished.
"I think over the next four years the equity will double in value from where it is today," he said.
ITV is another stock that the manager bought when it was in trouble, only to see it double in value, and shares this week hit their highest point since 2007.
However, the manager thinks finding this type of company is becoming more difficult, at least in the UK.
As a result he is focusing on Europe more; as much as 15 per cent of the fund is now invested outside the UK.
"Turnaround stories were at an extreme three years ago," he said. "There are fewer turnaround stocks than there were."
"Valuation convergence between the highest and lowest stocks had created an opportunity to buy growth at a reasonable price."
Shah says he expects there to be a period of consolidation later this year when the markets may relinquish some of their recent gains.
"At some point in 2013 there will be a drawn out consolidation period which will be a buying opportunity for equities."
"I think people are getting carried away as they did in 2009 with the outlook for global economic growth."
"Because it’s a long road to economic recovery and growth won’t recover significantly for some time, the catalyst for a market correction could be growth figures below expectations in the medium-term."
He stresses that he does not see the economy recovering for some time, perhaps for four or five years.
"We are at the very early stages of an economic recovery. It will take time for the normal business cycle to come back."
Shah is trying to find stocks he expects to do well in the early stages of an eventual recovery, such as media companies and telecoms.
He remains negative on commodities, viewing them as likely to do well in later stages of the business cycle.
"Until we get visibility on the business cycle coming back and sustainable growth, I am less likely to have later-cycle names like miners."
The manager says there are plenty of undervalued companies in the financial services sector in particular.
"Equities as an asset class are being held at multi-year lows compared with cash and bonds. One way of getting exposure to this theme is through asset managers. I hold F&C, which is a turnaround story and bought into Jupiter when it was at around 230p a share."
Jupiter now costs 343p.
Shah’s favourite financial stock is the London Stock Exchange, which has agreed a deal to buy LCH.Clearnet, London’s principal clearing house.
"It is a unique franchise benefiting from regulatory tailwinds post-financial crisis. Concerns about competitive threats were overblown and it was trading at multi-year lows."
"With the acquisition of LCH.Clearnet, it’s a good opportunity to move into clearing, with tailwinds they will see from the regulatory side. More trading will move back from OTC onto the exchanges."
Shah is also seeing opportunities in secondary property companies such as Max Property and Development Securities, which is a new theme in the portfolio.
He expects M&A activity to pick up, and TalkTalk could be one of his holdings to benefit. The sector is likely to see consolidation in the future, he explains, driven by the premium that will be placed on physical assets once the 4G networks are up and running.
The manager is also using the facility he has to short stocks to bet on falls in those areas of the market he thinks are over-held by institutional managers.
In spite of a poor 2010 and 2011, Fidelity Special Situations is a top quartile performer since Shah took over in January 2008.
The £2.4bn fund has delivered 34.03 per cent over this time, compared with 20.37 per cent from its IMA UK All Companies sector average, and 22 per cent from its FTSE All Share benchmark.
Performance of fund vs sector and benchmark since Jan 2008
Source: FE Analytics
It is only second quartile over three years, but a top-decile performer over one.
Fidelity Special Sits requires a minimum investment of £1,000 and has a total expense ratio (TER) of 1.7 per cent.
In an article later today, FE Trustnet will take a closer look at formerly out-of-favour funds with a value focus, which could be set for significant outperformance if Shah’s views are proved correct.