Very few activities in life are both worthwhile and easy, and investing is no exception. While jumping on the latest high-flying momentum stock might win you the support of your friends and colleagues, such a strategy is unlikely to be profitable long-term.
“The ultimately most profitable investment actions are by definition contrarian.” – Howard Marks
So, how can investors address the challenges of standing out from the crowd? To find out, we reached out to four funds who have never been afraid to do just that. Responses come from Alex Shevelev, Forager Funds; Michael Goldberg, Collins St Value Fund; Marcus Guastella, Lanyon Assset Management; and Tim Hillier, Allan Gray.
3 steps for better sleep
Michael Goldberg, Collins St Value Fund
One of the core challenges of any value investor, and particularly for contrarian investors, is an ability to maintain conviction in an idea even as the market moves against you.
There is no simple solution to this challenge, but there are three things we do to maintain our peace of mind.
1) Doing the research and testing it vigorously
Though our investment team tends to eventually come to a consensus, the process of getting there is quite boisterous. As a matter of process, whenever an idea is presented it is the role of one of the team to play devil’s advocate. A strong devil’s advocate ensures that all angles are considered and leads to a stronger outcome.
2) Recognise that the market is a little mad
We’ve recently described ‘Mr Market’ as a slightly mad person locked in a darkened room, where the only light being shone in is new information as it becomes available.
When left to his own devises Mr Market will imagine all sorts of terrible things in the corners of his darkened room and share prices will follow accordingly. However, given the time and guidance Mr Market will eventually realise that there is nothing to be afraid of, and again the share prices will ultimately reflect that reality.
3) When in doubt, work it out.
There is no better research than primary research. At times when the markets are moving in a direction that we don’t understand, we don’t hesitate to get out of the office and visit company operations unannounced. We’ve found that visiting operations, speaking with staff, managers, and customers will give us the type of information that can qualify our presumptions, give us an information advantage, and ultimately aid in achieving peace of mind.
When we were recently given cause to do so, our team took two days to visit 15 Reject Shops in the Melbourne area. In doing so, our investment team were able to achieve comfort in the outlook for the business even as official ASX announcements are not yet reflective of the improvement in business operations and sales.
The value in being different
Alex Shevelev, Forager Funds
Being a contrarian is a lonely existence. It means saying that a lot of other investors are wrong. And that makes it uncomfortable. It also makes being a contrarian potentially very profitable.
Let’s take Jumbo (JIN). The issues with the business were well known in 2015. Jumbo was wasting money overseas, had one critical supplier in Tatts who could kill the business with one decision and sells the same product as Tatts for a 10% premium. Everybody knew that. Taking a contrarian view involved coming to terms with just how much money would be wasted, how profitable the Australian business could be, and what the chances were of losing that big supplier.
That one turned out well - the stock is up from $1 to $6.50. But if it hadn’t, it would have been easy for our investors to turn around and say: “you guys should have seen that coming - everybody else did”. Which is why the opportunity was there in the first place.
Acting contrary to popular wisdom can mean getting investments wrong in some pretty obvious ways. We own Freedom Insurance (FIG) at the moment, for example. Forager bought the stock knowing that its sales model was potentially flawed but thinking that investors were getting compensated for the risk. When that risk comes to the fore, like it has for Freedom, you look like a complete idiot.
That makes having a supportive team, and supportive investors so much more important. The team thrives on the unloved and underappreciated and is on the lookout for the psychological biases of others (while recognising our own).
Our investors understand the sorts of stocks we are buying and, through plenty of detailed communication, why we are buying them. This means it is more likely they will stay invested through the inevitable periods of poor performance. Despite the discomfort, there is plenty of value in doing things differently from the pack.
Avoiding the dreaded “value traps”
Marcus Guastella, Lanyon Asset Management
Deep value investors are often buying unloved securities, which requires both independent and often contrarian thought. Because of this, we often identify stocks that the market has given up on or take views on sectors that go against broad market sentiment. Non-consensus views by their very nature tend to be incorrect more often than they aren’t, hence becoming comfortable with a contrarian stock idea takes significant time and relies on an extensive research process.
“You don't become a value investor for the group hugs". - Seth Klarman
Unfortunately, it is rare that we can pick market bottoms. Due to the unloved nature of our investments, it is not uncommon for us to see our best investment ideas, those with what we perceive to be the largest margin of safety, decline 10-20% before they revert to intrinsic value. Watching the prices of recently purchased securities continue to fall can often be both humiliating and frustrating. Often, at this point, we become overwhelmed with thoughts such as ‘what does the market know that we don’t?’
In order to maintain the discipline required to deal with this, we avoid market noise by completing thorough, independent investment research. In some cases, continually declining prices can create an opportunity to buy stocks with a larger margin of safety than we were originally offered.
A process of continual review and monitoring also helps us to identify companies that are not performing as we had hoped. In this way, we hope to avoid the dreaded “value traps”.
Conviction, discipline, and patience
Tim Hillier, Allan Gray
The most difficult part of being contrarian is managing human emotions. Many of the investments we make are somewhat uncomfortable, as concerns held by the market can be well justified. Rather than sitting back watching an exciting growth story unfold, we are often faced with declining revenues, plant closures and asset write-offs.
Investing this way requires belief in your convictions, discipline and patience. It may take years for our thesis to play out and the outlook may worsen before it improves, so we spend the time testing our thesis. We look for evidence that may not only support our assumptions, but also bring them into question or prove them wrong. Where the thesis remains intact, share price declines may provide an even more attractive opportunity.
This behaviour goes against many natural human emotions. However, we consider it our competitive advantage, and a distinguishing factor that has supported our outperformance over the long term.
More on deep value and contrarian investing
How do the contrarians and deep-value specialists of the world find their ideas in a market like today’s? Find out in part one of this Collection.