Running against the herd: Tips from Allan Gray's contrarian playbook
My "read" of Mawhinney may be partly due to his crisp elocution and measured, thoughtful responses, delivered in his calm and precise South African accent. But it’s largely because of what he says rather than simply how he says it, during his recent chat with my colleague Patrick Poke
When they last spoke, in March 2020, the ASX had plunged almost 4% in 24 hours and 20% in less than three weeks. And yet, Mawhinney presented as calmly then as he does in the latest recording.
“But in fairness, I think I’d probably underappreciated the severity of the virus and world governments' response to the virus… but the other side of that is that it’s clearly the time to feast when there is a lot of fear around,” Mawhinney says.
“These moments don’t come around too often in anyone’s life or professional career, and it’s very important to have a clear head, and that in itself is very difficult if you’re panicked. I suppose some parts of that do come naturally to me.”
During the interview, Mawhinney draws on the work of several doyens of the investment world, including Warren Buffett and Howard Marks. He also explains what it really means to be a contrarian investor – and it’s a lot more than simply doing the opposite of what’s splashed on the latest financial press headlines.
Alongside several lessons for investors on how to navigate uncertainty, he explains how his team values companies. This includes their process for selling stocks, an under-appreciated discipline that can be extremely difficult and which is often overlooked.
Mawhinney also discusses an Australian financial services company that they're actively investigating, and whose outlook he believes is much rosier than many people might expect.
“It’s the bus you don’t see”
Like scattered diamonds, poignant one-liners feature throughout the interview. One of these is a Mawhinney favourite that sums up the contrarian approach of Allan Gray’s stock selection process.
“It’s the bus you don’t see that kills you, but it’s also the bus you don’t see that suddenly turns the corner and gives you a ride home. There are times when your chances of catching a bus home are elevated, but you’ve got to make sure you’re at the right bus stop.”
This encapsulates how Mawhinney and his team think about stocks, in a process counter-balanced against the crowded trades that dominate market movements and the accompanying rhetoric. As he explains it, this approach brings the prospect of great rewards but is tinged with risk – though in fairness, so is all investing.
Incidentally, this isn't the first time Mawhinney's spoken about buses in this context, having mentioned them in a prior Livewire article. His prediction of a speeding bus in the near future in this wire published in December 2019 proved eerily prescient.
Investing in the face of extreme uncertainty
“Focus on price, because at the end of the day, the fundamentals come to the fore and end up bailing out share prices,” says Mawhinney.
Reflecting on his team’s own experience amid the calamity that kicked off last March, he concedes that at the time, they were set up for a “cyclical bounce” that had looked likely to them at the end of 2019.
“We were positioned poorly, but even so, I think that clarity of thought and calmness is essential when it comes to managing capital,” says Mawhinney.
At a time when no one knew where things were headed, they clung to an understanding of company share prices – specifically where they were positioned at that time versus their likely trajectory in the years ahead.
“For some companies, the pandemic destroyed one year of earnings, and so if you think of a company that might, on average, have a lifespan of 30 years, that’s a 3% value impost.
“If you contextualise it that way, it helps to think that ‘this price I’m paying is vastly lower than might otherwise be the case and might very significantly discount current events and make it very worthwhile allocating capital.’”
When to fold ‘em, walk away and run
As Mawhinney explains, “selling stocks is always a decision based on fundamentals, and we tend to exit positions when it’s no longer contrarian to be in them.”
“That’s when these deeply out of favour and disliked companies become a little more mainstream,” he says.
In most cases, it’s a cyclical effect that companies in their portfolio to weaken, “and so usually it’s the cycle correcting and earnings rerating upwards, and with it the share price.”
“But at that price, where we think the company’s underlying valuation reflects the likely future value of its earnings streams, we exit. We don’t tend to play the momentum game.”
That said, Mawhinney says a thesis like this will sometimes change – occasionally taking a 180-degree turn. But he’s adamant that his team exits as soon as a company’s share price reaches what they regard as its fair value.
The extreme circumstances last year meant Allan Gray Australia even turned over some companies in the space of around six months:
“That’s unheard of for us, with our average holding period of around five years. Those companies were mainly retailers that had done particularly well through government stimulus, and we thought there had been a very significant pull-forward,” Mawhinney says.
“It’s not to say I thought those companies were extraordinarily expensive, but there are other sectors or companies that you can rotate into, there’s always some cyclically depressed, out-of-favour company that you can invest in where, through a contrarian lens, hopefully, you can buy at a significant discount to fair value.
In this case, Mawhinney used the proceeds of these closed positions to fund their way into the new opportunities.
Happy hunting grounds for contrarian stocks?
“There’s quite a lot of hype and schizophrenia in stock markets at the moment, it’s quite a concerning backdrop,” says Mawhinney.
“Mathematically speaking, there are fewer opportunities today than there were a year ago.
“But in a relative sense, I think there will always be very good contrarian ideas and sectors that are out of favour, disliked and present potentially good entry prices. And I think that’s no different today.”
He points specifically to the energy sector as one which remains “very depressed” and a good source of contrarian capital – though not without some risk.
A “rosy” future for this unloved financial
Insurers also hold some appeal at the moment, along with a few other specific financial services companies, says Mawhinney. One of these is the annuities provider Challenger (ASX: CGF), a local market leader in retirement income products.
“There are concerns over its annuities business in the face of low interest rates and narrow credit spreads,” says Mawhinney.
“There’s always something, and it’s not to say these companies are all cheap because they’re disliked – but they are calls to action for us, and you see these share price weaknesses unfold and it is at least a catalyst for beginning a research process.”
Mawhinney describes the company as “somewhat flawed” – but as he explains, these aren’t fatal and actually feed into its appeal.
“Because at times of crisis, either by design or through its management, it forces itself to divest from risk assets.
“Like in March 2020, exiting its equity portfolio and high yield credit to de-risk the portfolio right at the wrong time. That would be one of my biggest criticisms of Challenger. Over time, I think there’s a lot of value destruction that unfolds, and it was the same through the financial crisis,” says Mawhinney.
But he believes there is a good chance the firm’s annuity streams could be repriced, “much like term deposits have done, and in time, things might get better in terms of what they can earn from their investments.”
“So, I think the future may be much rosier. I don’t know this for sure, but there’s every chance that Challenger’s share price is sufficiently low to factor in this weak status quo continuing for some years into the future.”
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Glenn Freeman is a content editor at Livewire Markets. He has around 10 years’ experience in financial services writing and editing, most recently with Morningstar Australia. Glenn’s journalistic experience also spans broader areas of business...