Allan Gray and our offshore partner, Orbis, describe our shared investment approach as “contrarian”. “Contrarian” is usually defined as “opposing or rejecting popular opinion or current practice”. Using this approach in investing focuses our attention to find value in an investment world which can be noisy and distracting. Radhesen Naidoo explains what this means in practice.
Following trends is comfortable. It’s human nature to want to be in with the crowd, or part of the herd. This is especially true when it comes to our finances: As individuals, we take comfort from sameness. It validates our thinking. However, the simple economics of supply and demand illustrate why this is not good for investing: If there is an increase in demand for an item, but supply is limited, prices tend to rise. But this does not necessarily mean the item is more valuable or that you are getting more value for your money; it simply means you are spending more. Think about it in reverse: If there is an item you really like, but you put off buying it and then find it on sale, don’t you feel like you have scored? Similarly, when we think about investments, we are cautious when prices are rising as paying too much is the easiest way to lose money.
As investors looking to buy companies at bargain prices, you can understand why we would need to swim against the tide to find opportunities. Generating client wealth over time requires us to make unpopular decisions, or to be different from the crowd. This does not simply mean we are contrarian for the sake of it; rather, this approach makes us highly sceptical. We thoroughly question our decision-making as we seek to find value for our clients. This has always been a hallmark of our approach.
We thoroughly question our decision-making as we seek to find value for our clients
Consider the use of our smartphones – or cellphones, as they were once called. Today, Apple and Samsung smartphones top the popularity charts, but this has not always been the case. It is quite incredible how loyalties change and popularity can shift. When Apple initially launched the iPhone in 2007, it was revolutionary and new. It arrived from nowhere to eventually unseat the market leader: Nokia.
Back in 2006, Nokia dominated the mobile phone industry. At the time, it may have appeared to be an obvious company to back. But while Nokia was busy selling millions of phones, Apple was developing the iPhone, and Google was getting industry players together to build open-source technology for smartphones. Nokia wanted nothing to do with Google’s venture, and within two years, the company was in crisis, losing market share and ultimately its brand status.
If you had the foresight and courage to invest in Apple shares back in 2007, you would have benefited from the value that has now risen over 10 times. Investing in Nokia at the same point in time, when it was well known and widely used, would have been an easier decision – but you would have lost a lot of money. Of course, with the beauty of hindsight, the decision seems obvious, but back then, going against the crowd would have been uncomfortable.
Over time there will be many companies like Apple and Nokia. If you invest before the crowd starts to pay attention, you can benefit tremendously. Of course, the next winner is not obvious: Identifying the winners takes careful research, high conviction and an element of luck as well.
How does this relate to contrarian investing?
As contrarian investors, we hunt for opportunities in areas other investors overlook. This often leads us to invest in companies long before they become popular. For example, we have found select companies in African markets which are not well known and are underresearched. The countries themselves have a host of political, economic, liquidity and regulatory challenges, and these factors make investors nervous. As a result, there are fewer willing investors than in more developed markets.
We pride ourselves on doing thorough bottom-up research to identify great businesses with a competitive edge. And we are not afraid to take a different view. We also acknowledge that simply being different is not enough; patience (as well as a pretty thick skin) is necessary to unlock the value.
Another application of a contrarian approach is investing in areas where expectations are lower, or in companies going through temporary difficulties – in other words, where levels of pessimism are above normal, resulting in share prices being unusually cheap. One example is our experience before and after an extreme market event, such as the tech bubble in 2000.
During the tech bubble, we avoided the very popular technology shares. They were the flavour of the month, with prices skyrocketing and investors piling in, afraid to be left out of the party. We were nervous: In our view, there was more to lose than to gain. The market did not agree with us, though, and our returns were under pressure. Clients were not happy. Eventually, it all came crashing down. While it was extremely uncomfortable at the time, our approach paid off.
Following the crash, technology stocks, once the darlings, were given pariah status. Unloved and unwanted, they began to attract our attention. Some of these businesses would survive and eventually show their worth again. We initially invested in Dimension Data during 2002, following the tech bubble, and then again during 2005/2006. It added tremendous value to our funds and was eventually bought out in 2010. Again, taking a contrarian approach paid off.
To get the benefit of the approach … you have to remain committed during some very uncomfortable moments
What does this mean for you as a client?
Everything we’ve said above sounds great in theory and feels comfortable when the going is good. To get the benefit of the approach, though, you have to remain committed during some very uncomfortable moments. You have to be comfortable with a fund that underperforms at times, owning the unpopular companies, and not owning the popular ones when they are doing well.
Today, a number of the companies Allan Gray and Orbis hold on behalf of our clients are out of sync with the broader market and, as a result, performance is under pressure. Throughout these testing periods, we continue to apply the same approach. There is old wisdom which suggests tasks that require discipline are the most value-adding over time. Our investment approach is no different.