INSIGHTS
                     
Contrarian Investing: Popularity vs. Profitability

Aug 2017 by Joe Burns

Contrarian Investing Popularity vs ProfitabilityIt was July 2007 when Chuck Prince made that fateful comment, expressing a sentiment that typifies the collective mindset during the latter stages of a bull market. A decade later, investors are challenged by the impact of top-down policy and fund flows overshadowing bottom-up valuation and fundamentals, and they continue to participate in a dangerous game of "follow the (performance) leader" across global markets.

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"WHEN THE MUSIC STOPS, IN TERMS OF LIQUIDITY, THINGS WILL BE COMPLICATED. BUT AS LONG AS THE MUSIC IS PLAYING, YOU’VE GOT TO GET UP AND DANCE. WE’RE STILL DANCING." - CHUCK PRINCE, FORMER CITIGROUP CEO


It was July 2007 when Chuck Prince made that fateful comment, expressing a sentiment that typifies the collective mindset during the latter stages of a bull market. A decade later, investors are challenged by the impact of top-down policy and fund flows overshadowing bottom-up valuation and fundamentals, and they continue to participate in a dangerous game of "follow the (performance) leader" across global markets.

Dancesteps

Undoubtedly, most investors intuitively understand the benefits of contrarian investing. The challenge is one of timing and execution (and of course, FOMO - "the Fear of Missing Out"). Deviating from consensus is increasingly difficult as markets continually trend upward, while the importance of moving away from the crowd increases just as it becomes more challenging.

Three trends highlighting general investor behavior have continued to dominate this year, including quantitative investing, passive strategies and long-only exposure. While these strategies are core to a balanced portfolio and can be “easy sells” for investors given the relatively strong performance and growing popularity, increasing exposure to fundamentally-driven, actively-managed hedged investments is similarly critical, and increasingly worth considering.

QUANTITATIVE VS NON-QUANTITATIVE FUNDS

Through the first quarter of this year, $4.6 billion of net new money flowed into quantitative funds, even as over $10 billion was withdrawn from non-quantitative funds, according to HFR. "Quants" now are responsible for 27% of all U.S. stock trades by investors, per the Tabb Group. There is little doubt that quantitative analysis and quant-based investing will continually gain in popularity. Gone are the days of analysts counting cars in a mall parking lot to see how the big retailers are doing: such techniques have been replaced by satellite imagery and the creation of large data sets providing more robust, efficient analysis. Long-term this trend is a definite positive for investors, but like all investing styles that "go mainstream," investors should proceed with caution before displacing fundamental analysis altogether. Recent popularity and immediate profitability are very often disconnected, and while quants should generally be part of a core hedge fund allocation, it's important to identify firms that enjoy competitive advantages in the space, such as scale.

PASSIVE VS ACTIVE MANAGEMENT

It is a self-fulfilling prophecy that passive strategies outperform as bull markets age, with fewer stocks on the proverbial leader board. But active management potentially creates significant value should equity markets correct. This is particularly true in relation to real "active" engagement by professional investors, who can invest in complex securities, identify catalysts ahead of the crowd and profit in both up and down markets. These styles of rigorous active investing, that rely on an edge like deep sector knowledge or skill at engaging with company management, offer much more than simple valuation screens that can be replicated by cheap, passive alternatives, and tend to be far less dependent on fund flows and market direction in generating long-term performance for investors.

LONG-ONLY VS HEDGED STRATEGIES .

The majority of hedged investment strategies not only protected capital for investors in ‘00-’02, they produced generally positive performance during the protracted market sell-off. Again in 2008, hedged strategies generally mitigated losses. But, subsequent policies have rewarded “long-and-strong” investments, and long-only strategies have continued to shine in 2017 and for the past 8 years. While that may continue for the months or even years to come, the contrarian investor is already increasing hedged investments to create a more balanced portfolio for a changing market environment. One of the ironies with contrarian investing is that it increases in difficulty exactly as it increases in importance. Embracing that challenge made Sir John Templeton one of the most successful investors in the 20th century. A true contrarian, he is credited with a number of valuable lessons, including one that rings particularly true today: "If you want to have a better performance than the crowd, you must do things differently from the crowd."

This article originally appeared in the WealthManagement.com 2017 Midyear Outlook.


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