Contrarian Investing

INVESTORS who like to take an opposing view to the rest of the market can make significant profits, but it does take nerves of steel to take a contrarian position and stick with it.

To do this successfully, you need to understand a little more about how this works, so here we explains the basics.

So what is contrarian investing?

Contrarian investing is where you take a position which is the complete opposite of the generally accepted wisdom or trend within the market. You have to have the courage of your convictions to undertake this strategy, as you are setting out on a course where you are swimming against the tide. It is a high risk strategy, but the rewards can be worth the risk.

Why on earth would I be looking to take an opposing view to the majority of investors?

Good question, and it is one you should ask yourself every time you look to take a contrarian position to be honest. It is not something you should do lightly, because there is an argument that the majority of investors cannot be wrong. However, markets run on rumours and sentiment, and there are times – especially when they go to extreme highs or lows – when perfectly good, solid companies or sectors fall out of favour for no other reason than people ‘think’ they are worth less than they are.

Of course, it works in reverse too. When markets and sectors are overvalued and investors are piling in like there is no tomorrow, you may want to take a contrarian view on the market falling.

Well, what difference does ‘what people think’ make?

It makes a big difference, because if you are prepared to stand by your research, or instinct, then you can buy into sectors or companies that are effectively on sale through no fault of their own. Think of it as a shopping trip, you would not wait to buy something until the price went up would you? Buying shares is no different, but you need to be able to sift out the bargains from the rubbish to make sure you are not paying for something that is not going to be of value to you.

OK, so how do I identify these companies and sectors that are worth taking such a chance on?

You need to look at the fundamental valuations of the companies or sectors in question, and consider why the price has dropped. If you can see a specific reason relating to the company itself that has caused its price to fall, such as a profits warning, a major change in the board or another reason that is specific to the way the company itself is being run.

If there is nothing specific that you can identify, other than perhaps that the sector itself has been hit because of, perhaps, political decisions or the wider economic climate taking its toll, then it might be worth a closer look. A company – or fund for that matter – that has seen its price drop without a good, fundamental reason is worth considering for a contrarian investment position.

I don’t think I can be bothered to do all that research, is there another way I can find out what I need to know?

You could speak nicely to your adviser to get them to do the leg work for you. In fact, a good adviser should be helping you to make the most appropriate use of the money within your portfolio, and if you are prepared to take a contrarian view, you could see significant benefits when the company or sector comes back into favour. It is all about steeling your nerves, and believing that the position you have taken is correct.

Hmmm, easier said than done. Are there any famous investors who are contrarian that I can get some tips from?

Actually, yes. One of the world’s most famous – and most successful – investors is a contrarian. George Soros, the so-called ‘Man who broke the Bank of England’ because he made an unimaginable $1 billion in a single day because he took a short position on sterling on Black Wednesday in 1992, which forced the UK out of the European Exchange Rate mechanism. In hindsight, it may have been a good thing given what is happening to the euro right now.

So is it only in extreme times that contrarian investing works?

No, not exactly, it is just easier to find valid examples to take a position on when markets and sentiment are operating at extremes. There will always be situations where you can find companies that have seen their share prices fall because of external factors, but without extremes, you will have to look harder to find them. This makes it more labour intensive, but there can be real rewards if you get it right.

The obvious place to take a contrarian view would be Europe at the moment I would say, am I getting the hang of this then?

Yes, it sounds like it. There are some real problems in Europe with sovereign debt crises playing out in Portugal, Ireland, Italy, Greece, and now possibly Spain, not to mention France and Belgium seeing the interest payments they need to pay for their borrowing rising sharply. But this does not mean that the companies within the European markets are in a worse position than they were six or even 12 months ago.
Vincent Devlin, manager of BlackRock Greater European Investment Trust plc, said that despite the problems in Europe, it still contains “some of the healthiest economies in the world and a high number of world leading franchises”.
He added: "If confidence returns to the region, we would expect Europe to perform very well as an investment region."

But remember, there are problems worldwide, so you could argue the same applies to companies in the US and Japan, and other Asian markets. Currently, there are opportunities in so many areas that it is certainly worth a look.

Should I stick with what I know, investment wise I mean?

That makes your research easier, for sure, and it will also help you to understand when to change your view. But again, your adviser should be able to help you with this, so if you have the stomach for it, take a look at being contrarian. Just do not expect to be as successful as George Soros. Yet.

For further information why not contact
Paul Dodd Senior Financial Consultant @ Infinity FS
Pdodd [at] infinityfinancialsolutions [dot] com
Or call 089 330082 to make an appointment and review your financial situation for 2012

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