Portfolio Adviser • New PA Mag July/August • Contrarian

It is the ability to be contrarian that sets the Warren Buffetts and Howard Markses of the investment world apart. Have you got what it takes to stand out from the crowd?

Lockdown, by dispensing with the norms of everyday routine, provides us with the opportunity to be introspective. To ask ourselves those questions we often choose to ignore or of which we fail to realise the importance. For me, there are three questions to which I return, day in, day out: What makes a good investor? What type of investor am I? How do I become a better investor?

These seemingly simple questions are fraught with behavioural biases, but an ability to answer them is essential to any investment success. Everyone wants to know how to become a legendary money maker. Yet, contrary to the claims of the hundreds of books on the topic, there is no magic formula.

Is it significant, for example, that Warren Buffett is based in Omaha, Nebraska, not Wall Street, New York? Does being away from the hubbub of financial markets improve your investment acumen? Before you up sticks and buy a one-way ticket to Greenland, your location may help but doesn’t necessarily guarantee you results.

In fact, the majority of us are destined to be average investors at best; by construction, this has to be the case, hence the popularity of passive investing. Rather than hoping to be better than average, you recognise the improbability of achieving this outcome and accept average returns instead.

I do believe investment skill exists, meaning it is possible to consistently outperform the market. Such money managers are rare, however. After all, if their skill was commonplace, it would provide no advantage over others.

Standing testament to this are the likes of Warren Buffett or founder of Oaktree Capital Management Howard Marks. But what makes them so special? Apart from an intellectual humility – namely, a recognition of their own fallibility – they both demonstrate unusually independent judgement. Or, as Howard Marks puts it: “To do better than most, you have to depart from the crowd.”

In October 2008, for example, with stock markets crashing and financial Armageddon seemingly only days away, how many of us were willing to invest our cash? Howard Marks invested $450m (£367m) per week for the last 15 weeks of 2008.

Warren Buffett went one step further. Not only did he merrily backstop the likes of Goldman Sachs and General Electric with billions of dollars in cash, but he also put pen to paper, in a New York Times oped, to tell everyone he was doing so.

It is this ability to be a contrarian that is a common trait among some of the great investors of our time.

If contrarianism is their investment mantra and has proven to deliver outsized returns – in the past 55 years, for example, Berkshire Hathaway has outperformed the S&P 500 by around 2,700,000% – why is it not more commonly pursued in mainstream investing today?

To be a contrarian investor requires one to be independently minded and, sometimes, willing to be derided for being so. It is a lonely place to be. But more than that, faced with moments of doubt and self-questioning, to maintain such a stance requires a strength of character, or perhaps better yet a streak of stubbornness, that is absent in most of us today.

Buffett says: “Temperament is more important than IQ. You need reasonable intelligence, but you absolutely have to have the right temperament.”

A further challenge for the professional investor is finding a client base that will stay loyal to a strategy despite the inevitable bouts of poor performance. Sadly, in the era of benchmarks and monthly reporting, this is increasingly difficult.

To top it off, career risk and the threat of lost earnings due to severe underperformance dissuades the vast majority of fund managers from adopting a contrarian stance.

Professional investors expect growth stocks to outperform value stocks, ie those with the strongest earnings’ increases should deliver the best share price performance. This expectation is a logical extrapolation of recent history.

Since the global financial crisis, growth stocks have outperformed value stocks in a near constant upward trend. And while it has been most evident in the US, it has been prevalent in all equity regions.

In fact, on 15 May, the Russell 1000 Growth Index moved to its greatest ever outperformance of the Russell 1000 Value Index since early 2000, just before the dotcom bubble burst. Because the scale of outperformance has already reached previous historical highs does not necessarily mean it won’t continue. Indeed, professional investors are assuming it can.

But it does raise the question: at what point should this performance differential converge? After all, if the answer is ‘never’, investors are tacitly saying there is no relative price at which growth stocks become too expensive – or value stocks too cheap.

This growth versus value stock debate is exemplified by the dominance of FAAMG (Facebook, Amazon, Apple, Microsoft and Google). With the benefit of hindsight, and like most professional investors, I wish I had bought them 10, or even five years ago.

However, with FAAMG stocks now representing almost 23% of the market capitalisation of the S&P 500, their share prices having nearly quadrupled in the past four years, is now really the time to be buying a group of stocks trading on multiples in excess of 30 times earnings?

I keep returning to one of Marks’ phrases: “Trees do not grow to the sky”. Despite FAAMG being well-run companies with strong balance sheets, surely there is a price that is simply too high to justify continuing to own them.

According to Research Affiliates, value stocks are trading at their cheapest valuation relative to growth stocks on pretty much all metrics. While this is certainly not a reason to expect a style reversion, it does flag the dangers of positioning yourself with the herd and being overweight growth stocks today.

Much to the frustration of my ex-colleagues, I am a contrarian at heart and am always keen to take the other side of a debate. Today, that debate is about whether to chase growth stocks or start buying into more value opportunities. I know where I’ll be placing my money.