Steve Thaxter- Senior Partner and Principal Adviser
Sovereign Wealth Partners
Most people in our industry agree that the biggest pitfall for investors, experts and lay people alike, is the tendency to extrapolate recent history. The alternative is to be contrarian, in the words of Warren Buffet to “be fearful when others are greedy, and greedy when others are fearful”.
This sounds great but is actually very difficult in practice as Baron Rothschild urged us some 200 years ago when he advocated “buying when there’s blood in the streets even if the blood is your own”. There is little evidence that many mortals are able to heed this advice, the psychological barriers are just too daunting and of course some of those who have the courage to be contrarian lose their conviction (or their shirts) before the investment markets eventually turn in their favour.
The question of how long to hold a contrarian position is of course one of life’s imponderables. The evidence shows that whilst investment markets can be “wrong” for long periods of time, when the economic and investment pendulum eventually cycles back through its central point rational valuations will again be observed. For this reason, over the full boom/bust cycle, the journey will always be smoother if valuation signals are not ignored.
This is important to us as:
- whatever the investment markets serve up, successful investors (read our clients) have to live to fight (invest) another day
- our client’s timeframes are typically long. Usually lifetimes and generations that span multiple weird and wonderful investment cycles.
Is there a middle road? Yes. It is the job of InvestSense, one of our investment research partners to assist us in positioning and explaining portfolios with an eye to the future, rather than the rear-view mirror.
By trying to be objective and answering three questions InvestSense aims to look through the noise and emotion in investments and come up with likely outcomes. Be they individual investments or whole asset classes, the three questions are:
- What are the current cash flows (dividends)?
- How fast are they expected to grow (e.g. in line with the economy, faster than that in a growth sector/economy or more slowly for more mature economies and companies)?
- Are they cheap or expensive relative to their history (what would happen if investors in the most loved sectors fell out of love with them and vice versa)?
This gives a sense of the trade-off between potential risk (how much you could be down over a short period) and likely reward (how much that investment is expected to grow over the long term. The following chart shows how different equity markets currently rank on the InvestSense dashboard.
It is interesting that we hear from the better fund managers, some of which have a contrarian bent, that the only really cheap assets left in the world are emerging markets value stocks (think Hong Kong real estate!). Meanwhile there is also evidence that some of the most popular and expensive growth stocks are headquartered in the US. We are still actively invested in that area (think Apple, Facebook and Google) as these titans are too big to ignore but are looking to tilt portfolios towards areas which have been less in favour, such as emerging markets and even Europe and Japan.
If you are interested in learning more we can step you through how these dot points combine to form our most preferred portfolios and what our expectations are for the risks and returns we’ll experience.
But if you simply don’t have the time to engage to that degree you may get some comfort from knowing that the advice we give, the investments we recommend and the decisions we make together are predicated on this type of thinking – always looking forward and perhaps a little contrarian when needed.