Amie Baker (left), Chris Hestelow and Anne Clare

Being a contrarian investor might seem like a distinctive investment position to take, but for advisers it can be a crucial part of portfolio diversification.

A believer in the philosophy, Allan Gray investment specialist Chris Hestelow says that contrarian investors will inevitably go through periods of underperformance, and often this will happen at times when more popular assets are doing well.

But at the same time, he adds, following the common “wisdom of the crowd” in the investment markets can be “quite dangerous” and lead to adverse impacts.

If investors follow trends and focus on buying popular stocks, securities or companies, this creates a situation in which the optimism drives these securities up very quickly and can make them overpriced.

“At its worst, it can create these big market bubbles when things become very overpriced and, of course, that creates a greater risk of permanently impairing shareholder capital,” Hestelow says.

According to the fund manager, whose analysts are tasked to seek out value “wherever possible”, there currently is a big valuation dispersion in the market.

Hestelow says that on a sectoral basis, information technology and healthcare in Australia looked very expensive, when – for example – the energy and material sectors trade at discounts to the broader markets.

“What we are trying to do is not to overpay for assets, [because] when you pay too much for an asset then you really need everything to go right and more to outperform and make good returns for your clients,” Hestelow says.

“[But] where there is more pessimism around the particular company, you just need that company to do better than a broader market expects. We are looking for those companies that trade at a very significant discount to what we perceive their intrinsic value to be.”

Hestelow adds the best way to avoid the value trap is to stay focused on the investment fundamentals and constantly reassess the value of each company in the portfolio.

“Even if the share’s lost you money you need to be able to look at it with fresh eyes and if it is worth less than it is currently trading at, you should be comfortable exiting that position and taking the loss and seeking out better opportunities elsewhere,” he says.

Advisers and contrarian products

Advisers use contrarian products to achieve greater diversification for their clients and capacity for better returns over time, however those products usually make up a small portion of clients’ portfolios, sitting at around 5-10 per cent.

“To my mind it is a really logical addition to a portfolio,” Anne Clare, director at Ardour Financial Advice and a client of Allan Gray, says.

“The biggest risk is in the investors’ behaviour [and] making sure that the client understands the need to hold their exposure through the cycle.”

Clare says she uses contrarian investment options because it is typically uncorrelated to indices, as well as other managers.

“It gives clients diversification across assets class and within an asset class,” Clare says.

“It really gives clients the potential to get a different outcome which protects portfolios and provides a more consistent return over time. I also use it as an alpha generator to generate better returns for clients through a market cycle.”

Clare says that clients grow impatient when these products underperform for a longer period of time and then it gets very easy for them to start thinking about exiting the strategy altogether before they should. “Then [they] miss out on the whole reason for being there,” she says.

According to Rekab Advice and Centsability director Amie Baker, who is also an Allan Gray client, it is advisers’ job to educate the clients and help them understand the fund managers’ strategies and explain, when necessary, their historical performance and when the fund did well and why.

“The whole purpose is the overall outcome the portfolio delivers, as a whole, is actually looking at each fund manager and their individual performance so we are expecting that some of those are going sometimes to be negative,” Baker says.

“That is okay that they are because they’ve got their purpose. Some clients will get a bit nervous… and it is our job to educate the clients and help them understand if we are going to make an adjustment to the portfolio and why we would be doing that, I use the term [like with Allan Gray funds] that is our insurance policy so to speak.”

Baker believes there is always space for a contrarian fund when constructing a portfolio.

“We have to look where we can diversify as much as possible, but also where we can get the returns,” Baker says.

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