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The simple economics of supply and demand illustrate why following the crowd 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.
This is the view of Radhesen Naidoo, business analyst at Allan Gray, who uses an example to explain the concept: 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, as a contrarian investor, we are cautious when prices are rising, as paying too much is the easiest way to lose money,” he says.
Smart ideas
Naidoo says that Apple and Samsung smartphones weren’t always popular.
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 market.
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 benefitted from the value that has now risen over ten 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. Going against the crowd back then would have been uncomfortable,” says Naidoo.
He explains that if you invest before the crowd starts to pay attention, you can benefit tremendously, but identifying the winners takes careful research, high conviction and a bit of luck.
How does this relate to contrarian investing?
Naidoo explains that contrarian investors hunt for opportunities in areas other investors overlook.
This leads to investing in companies long before they become popular.
“We have found select companies in African markets that are not well-known and are under-researched. 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.”
Another application of a contrarian approach is investing in areas where levels of pessimism are above normal, resulting in share prices being unusually cheap, such as before and after 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.
Eventually, it all came crashing down. While it was extremely uncomfortable at the time, our approach paid off,” says Naidoo.
Following the crash, technology stocks, once the darlings, were given pariah status.
Unloved and unwanted, they began to attract Allan Gray’s 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 and 2006. It added tremendous value to our funds and was eventually bought out in 2010. Again, taking a contrarian approach paid off.”
What does this mean for investors?
“To get the benefit of a contrarian investing approach, you must remain committed during some very uncomfortable moments.
You must be comfortable with a fund that underperforms at times, owning the unpopular companies, and not owning the popular ones when they are doing well,” says Naidoo.
Today, several opportunities may appear to be out of sync with the market for contrarian investors and as a result, performance is under pressure.
“Generating client wealth over time requires contrarian investors to make unpopular decisions. 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,” concludes Naidoo.
This article originally appeared in the Fund Focus supplement in the 21 November edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.
