What is contrarian investing?

Now, our third speaker of today's Australian perspectives is from Alan Gray.

The Alan Gray Australia Equity Fund is to provide long-term returns that are higher than the benchmark, the S&P and ASX 300 manipulation index.

Joining us is their business development manager, Mr. Chris Hesterloh.

Welcome, Chris.

Chris's title for today is, What is Contrarian Investing?

Thanks so much, Angelina.

And thank you viewers.

I'm very grateful for the opportunity to speak a little bit today about contrarian investing.

Before I get underway, I should mention that anything I say today is of course general in nature, doesn't take into account the viewers personal needs, objectives or circumstances.

If you are in need of personal financial advice, I would encourage you to seek the assistance of a qualified financial planner.

As humans, we've really evolved to seek the wisdom of the crowd.

For all of human evolution, it was quite dangerous to be the odd one out or the one that was outside the tribe.

And it's for that reason that we've developed kind of an intrinsic need to copy what those are doing around us.

Even today, you know, we look at TripAdvisor and Amazon reviews and Google reviews because we want to imitate the best travel habits, the best eating habits and the best shopping habits.

Usually this is a pretty good strategy.

If we think about engineering, if we were building a bridge and 99 out of 100 engineers said that we need a certain amount of concrete and a certain amount of reinforcement, and there was one engineer who said, no, don't worry, you need much less concrete, much less reinforcement.

Here's my design, follow my design.

You'd be well advised to go with the 99 and not listen to the contrarian in that scenario.

Usually, seeking the wisdom of the crowd is quite a good strategy.

But in investing, things are quite different.

And going with what everyone else is doing and copying others

can sometimes be quite dangerous and lead to adverse investing impacts.

Copying what everyone does around us in investment markets often leads us to buy those shares that have a great story around them, that everyone says are great investment opportunities.

Usually they've done very well in the recent past, and they're comfortable to invest in.

What often happens in those scenarios is that very quickly those stocks become overpriced and can trade at prices above their intrinsic value driven by the optimism of the crowd.

At its worst, it can lead to market bubbles where prices become completely dislocated from their fundamental value and the incremental investor that comes along and purchases the next share

overpays and permanently impairs their capital when the bubble inevitably bursts.

Those forces that can drive share prices up and up on widespread optimism work just as powerfully in reverse.

And so those stocks that don't have such a rosy story that have done poorly in the recent past, or that are uncomfortable to invest in, can often trade at discounts to intrinsic value due to an overreaction and people being overly pessimistic.

Those are the companies that we seek to look at and invest in if the price makes sense.

Companies can be out of favour for a multitude of reasons.

They may have disappointed on earnings, the market may have lost faith in the management team, or they may be exposed to a commodity that's at cyclical lows.

We look to buy those companies that are out of favour and that where there has been a reaction and a mispricing has occurred.

We are long-term investors, so our average holding period is much, much longer than the average market participant on the ASX.

And that seems to complement the contrarian way of doing things.

Often it does take some time for the news cycle to move on or for the rest of the market to come around, I guess, to our view and realise that there's been an overreaction to the downside.

We are also fundamental investors.

So we employ nine analysts in Sydney from a very diverse range of backgrounds, including academia and consulting.

And it's their job to do the hard work to formulate an independent view of the intrinsic value of a business.

And that informs our buying and selling behaviour.

This is a bit of a stylised view of what we're trying to achieve and how we're trying to invest.

You can see that assessment of intrinsic value in the grey that I mentioned, it's the analyst's job to calculate and form a view on.

And you can see share prices generally oscillate a lot more than the actual value of business.

We look to buy prices below the intrinsic value as mentioned, but one interesting thing to note is that that black dot is not right at the bottom of the curve.

We can never know where the bottom is.

Usually the selling behaviour is being driven by human emotions and human biases.

And so it's for that reason that we usually take a bit of a position in a stock.

If it continues to trade off and our assessment of true value hasn't changed or has increased, we'll build that position over time on subsequent weakness.

The nice thing about being a price-focused investor is that you know exactly when to exit a stock, and that's when it reaches our assessment of intrinsic value.

We don't try and ride the wave of optimism that can sometimes come after that point, as we believe it relies on, I guess, the greater fool buying the share off you.

And so it's almost a function of the approach that we get in early and get out early.

But that is the best way that we think we can manage money and deliver excess returns and alpha to our clients.

There is some empirical evidence for a contrarian approach.

So the Brandeis Institute some time ago conducted what they called a falling knives analysis.

In this analysis, they defined a falling knife as a stock that had fallen 60% or more over a preceding 12 month period.

And they then took those stocks and tracked how they did in the subsequent three years.

In the US, including companies that went bankrupt, the knives delivered a return of 11.2% relative to the 4.6% of the S&P 500.

And when they took that same methodology outside the US, the non-US knives delivered 10.8% relative to 5.3% for the Miski index.

It should be said, we don't just go out and buy companies that have fallen and because they've fallen, but that's usually what piques our interest and where the research process might begin.

One of the reasons that contrarian investing works is that share price returns are not so much based on business outcomes as they are based upon business outcomes relative to market expectations.

What I mean by that is, if a stock is priced for a great outcome and merely delivers a good or an average result, you can do quite poorly as an investor and the share will often sell off.

We see this very often, often a company will come out, release its annual report and they have record profits, record earnings.

But on the day that it's released, the share price falls in value, which can be confusing to a lot of market participants.

The reason that that happens is because the market was expecting an even greater result.

And that's really what we mean when we say a stock is priced for perfection.

On the other side of the curve, if we look at point B, if everyone expects a dreadful outcome for a business, expects nothing of the business, and it goes on to deliver a poor or even better an average result to oversimplify things,

You can do quite well as an investor and see share price appreciation.

And so it's for that reason that we don't need a miraculous turnaround in the fortunes of these companies.

We don't even necessarily need a catalyst.

We just need the future to be a little bit brighter than the broader market is expecting.

And that can become a lower hurdle when there is widespread pessimism and no one expects anything of the business.

To be a contrarian investor, you do need to engage in a lot of second level or second order thinking.

First order thinking would be using rules of thumb, or I guess what's called heuristics and behavioural finance.

You know, this share's done very, very well.

Everyone else is buying it.

I've got to have some in my portfolio.

Or everyone's saying a recession's around the corner.

I want to skew my portfolio heavily towards consumer staples or whatever it might be.

What is missing in that conversation or that level of analysis is the price that you're paying for a security.

Any company's value is the future earnings that it will generate for us as owners discounted to today.

And so as long as those earnings aren't zero, there is a price at which it makes sense to buy almost any company.

And conversely, there's a price at which you would be overpaying to own any company or asset.

As one of my favourite investors, Howard Marks says,

It's not just about buying good things.

It's about buying things well.

And so we need to engage in second level thinking.

We need to think about what is the range of likely outcomes and what do we think will happen?

What is the probability that we're right versus what is the consensus think and how are our expectations different?

In all likelihood, the person that is on the other side of the trade to us is just as motivated and just as smart, if not smarter,

And so we need to think quite a lot about why they are willing to sell us a share at a price that we think is below its intrinsic value.

And so I guess to summarise, enduring human bias does create opportunities for contrarian investors.

It does require restraint, patience and commitment in our convictions.

Now, often we're buying the kinds of companies that everyone tells us not to buy, and often they're proven right.

And so you need the fortitude to deal with that.

it's not easy to be different, but the rewards can be great.

And we think it's very, very worthwhile.

Thanks very much.

Thanks, Chris.

Thank you for your insight in controlling investing.

Now I have one question for you.

So what funds do Alan Gray currently offer to the Australian investors?

And do you consider the macroeconomic issues in your approach?

Great.

Thanks, Angelina.

So we currently offer three funds under the Alan Gray Australia brand to the Australian market.

The first is a flagship equity strategy that's mandated to be fully invested in Australian companies, benchmarked against the ASX 300 index.

The second is our balance fund, the Alan Gray Australia balance fund.

It probably gives us the widest playing field in terms of the different type of assets we can purchase.

It's benchmarked 60%

growth assets, 40% defensive assets.

And then within those sleeves, again, 60% domestic assets, Australian assets versus 40% global assets, with that global portion being managed by our sister company, Orbis, who has the exact same investment philosophy as us.

And then the third fund we offer is our most conservative fund.

It's called the Alan Gray Australia Stable Fund.

It starts with 100% in cash and that is term deposits less than 12 month maturity or Aussie government bonds less than 12 month maturity.

And then when we think Australian shares are coming up as more attractive than cash on an absolute basis at the individual stock level, we can purchase positions in Australian companies up to a maximum of 50%.

And so those are the three funds that we offer.

In terms of that second component to your question,

Do we focus on the macro side or the macroeconomic side?

We intentionally don't.

We intentionally don't employ macroeconomists in our business.

We do need to think about different states of the world and what it might look like for the businesses that we invest in.

But when you take things out to the macroeconomic level, there's just such a huge multitude of variables that need to be taken into account.

And it's very, very difficult to predict things with accuracy.

And we've seen a lot of that recently, you know, the central banks employ hundreds of economists, and seem to be continually surprised by the next set of data that comes out.

And so we don't focus at that level, we really are fundamental investors, the number of variables become small, when you focus on the individual businesses,

and the earnings that we expect them to generate through the cycle.

And so that's where we spend most of our time.

Thank you, Chris.