Reap big rewards with contrarian investing

Although many innovators are hailed for their ability to go against the grain (think Steve Jobs, Nikola Tesla and J K Rowling) when it comes to investments, most people tend to follow the crowds. After all, there’s safety in numbers and, when it’s your money on the line, safety is the name of the game.

However, by following the investment crowd you may be missing an opportunity reap rewards and diversify your portfolio. In this article we cover what contrarian investing is, who’s doing it and why it may be worth the risk.

contrarian investing

What is contrarian investing and how does it work?

Contrarian investing is a style of investing where people actively go against market trends. A contrarian investor will usually enter the market by buying when most are selling or selling when most are buying. While others will exhibit a negative sentiment towards an investment, thus pushing the price down, a contrarian investor will see an opportunity to purchase below market value before the share price increases.

Baron Rothschild, he of the Rothschild banking family, is credited with saying “Buy when there’s blood in the streets, even if the blood is your own.” He should know. Rothschild made a fortune buying in the panic that followed the Battle of Waterloo against Napoleon. And they haven’t done too badly since.

Investing far from the maddening crowd

Contrarian investors have an inherent belief that the market over-reacts to good and bad news, and aims to take advantage of this. They view short term movements in share price as misrepresentative of a company’s long term fundamentals. So by buying an investment that is under-priced by the market today, the contrarian investor creates the possibility for large returns if the investment comes back into favour. Equally, if a company has some positive news and their share prices jumps up, a contrarian investor may view this as being the perfect time to sell before the share price drops back to a more realistic level.

Contrarian investors make their best investments during times of turmoil for the markets. The 45% drop in the bear market in 1973-74, the ‘Black Monday’ crash of 1987 and the 9/11 attacks of 2001 all resulted in sizeable market drops. These were some of the times when contrarians found their best investments.

After the September 11th terrorist attacks, for example, the world stopped flying. Within a year, Boeing (BA), one of the world’s largest builders of commercial aircraft, saw their stock bottom out. A contrarian investor would have invested at this moment as, from there, it rose more than four-times in value over the next five years. Although September 11th soured market sentiment about the airline industry for a period of time, those who were willing to bet that Boeing would survive were well rewarded.

Some of the most famous names in investing are contrarian investors. Warren Buffet’s famous mantra “Be careful when others are greedy. Be greedy when others are fearful” perfectly encapsulates the contrarian way of thinking. At the height of the 2008 financial crisis, Buffett advised investors to buy into American companies like Goldman Sachs. Ten years later, Goldman’s stock had risen 196%.

Other examples of contrarian investors include David Dreman, author of Contrarian Investment Strategies: The Next Generation and Michael Burry, the hedge fund owner who shorted the subprime market and was later portrayed by Christian Bale in The Big Short.

What are the risks?

As with all investments, the markets are not always rational and can sometimes act in ways that don’t represent the fundamentals for long periods of time. Contrarian investors would argue that owning out of favour assets that have strong fundamentals but are trading below their intrinsic value is a low risk / high reward strategy, while others would say there is a reasonable amount of risk involved. Although purchasing an investment at a price below its intrinsic value may seem like a great opportunity, there’s no guarantee it will reach a higher value. Just ask any investor who bought into companies like Kodak, Nokia Dell and Blackberry thinking they were sitting on promising contrarian opportunities.

The most successful contrarian investors do a serious amount of research before deciding to invest. Just because a stock takes a nosedive doesn’t mean it is guaranteed to come back. You’d need to find out what has driven the stock down and whether the drop in price is justified. Only then could you make a determination as to its future potential.

What kind of investors could consider adding contrarian funds to their portfolios?

Contrarian investors tend to be ones who are willing to take more risk than those who are more faint of heart. The strategy can fall out of favour in certain markets and, as such, should be part of a well-diversified portfolio looking to make returns over a longer time period, say 5+ years.

What percentage of an investor’s portfolio could contrarian funds make up?

A true contrarian investor would likely say 100%, but this is only applicable if you are willing and able to put the work in to find and research these investments. For investors who are looking for a little less risk and a longer investment horizon, 10 – 20% should be reasonable.

How can you get into contrarian investing?

Before you start down the route of contrarian investing, you need to understand what you’re looking for. And that means doing research. A lot of it. All investing comes with an inherent level of risk and contrarian investing is no different. There are hundreds of guides to investing to be found online but as a general rule you should be checking your finances, setting goals and timescales and choosing a strategy to suit you.

If you’re looking to buy shares online you’ll need to open a share dealing account with a stockbroker. The biggest difference between these providers will be their fees, so be sure to find a dealing option to suit you. The Share Centre, for example, offers a Share Account with a fixed £2 a month admin fee and then a small charge for each deal, which varies depending on how frequently you want to invest. 

If you’re looking to invest but are happy to let someone else manage most of the work for you, you could look at investing in a fund that utilises a contrarian approach to selecting investments. This will allow you to invest in multiple companies at once which are overseen by one or more fund managers. Some examples of these types of funds you could buy into are:

FP Crux UK Special Situations fund

Manager Richard Penny has adopted an approach with a value bias to seeking out businesses that are under-researched and under-priced. Often these companies are in recovery mode and have previously fallen short of expectations or may have valuation anomalies. Furthermore, it is hoped that a catalyst can be identified that will cause the market to re-evaluate the fundamentals of a company.

Investec Global Special Situations

The fund invests around the world primarily in the shares of companies using a value-based, contrarian approach to selecting investments. The managers operate a well-diversified portfolio of 40-50 high conviction stocks, spanning across a range of regions and sectors. The fund has shown strong outperformance of the sector on a 3 and 5 year basis.

Liontrust Special situations

Managers Anthony Cross and Julian Fosh have successfully implemented their disciplined investment process and philosophy over a number of years. There is a bias towards relatively steady companies that are growing sustainably and generating high levels of cash, but also that have a clear competitive edge. Performance since inception has been very strong; with the fund comfortably outperforming the FTSE All Share over this period.

The bottom line

While all successful contrarian investors have their own strategy for valuing potential investments, whether that be Baron Rothschild in the 18th century or Warren Buffet in the 21st, the aim is always the same –let the market bring the deals to you, rather than chasing after them.