Being ‘contrarian’ is about culture and about behaviour, and the outcome is reflected in portfolios that are different from the market. LJ Collyer and JD de Lange use the Allan Gray Australia Equity Fund to illustrate Allan Gray Australia’s contrarian approach to investing, an approach that it shares with its local counterpart and Orbis.
The problem that many analysts face is that, if they invest in an unpopular company and it goes well, they may get a bonus, but if it goes wrong they may well lose their job. Although an unpopular investment may prove to be the correct choice over time, external pressures often don’t allow money managers to hold their unpopular investments for long enough to unlock the value.
For most investment managers, the downside ‘career risk’ of being contrarian is much higher than the possible ‘career upside’. This is one reason why many larger corporate asset managers across the world use a benchmark as their departure point when they make investment decisions. Like Allan Gray locally, Allan Gray Australia does not believe in using a benchmark as a starting point. Rather, analysts start from scratch and invest in undervalued companies, which they believe have the potential to deliver superior returns for clients over the long term.
Graph 1 demonstrates the results of this approach, reflecting two key points:
1. In Australia, the largest five ‘active’ investment managers tend to follow the index
The dark grey bars show the weight of the 10 largest stocks in the S&P/ ASX 200 Accumulation Index (ASX) benchmark. This highlights the concentration of the Australian market to the larger shares, with the top 10 shares in the S&P/ASX 200 Accumulation Index (ASX) making up a full 55% of the market.
The light grey bars show the average holdings in the same stocks for the five largest Australian equity fund managers who claim to take an ‘active’ investment approach. The extent to which these well-known and well supported managers give investors access to broadly the same holdings is indicative of the challenge for equity investors who want exposure to a differentiated equity opportunity set in Australia.
2. The Allan Gray Australia Equity Fund looks very different from the index and its peers
The red bars on the graph show the Allan Gray Australia Equity Fund’s holdings in the same stocks. The conclusion is that the Fund is vastly different from the index and the largest active managers. Indeed, the top 10 shares listed on the ASX make up just 17% of the Australia Equity Fund.
Being contrarian means finding value in unrecognised opportunities
So if the Australia Equity Fund is not invested in top tier stocks, where is it finding opportunities? As contrarian investors, we spend most of our time analysing companies that are out of favour with the market. We look past faults others may find and try to identify areas of value that the market doesn’t fully recognise. Over the past five or six years, small- and mid-cap stocks in Australia have underperformed considerably relative to large-cap stocks, as shown by the light grey line in Graph 2. This is in contrast to most other developed markets where the smaller end of the market has outperformed the large caps (the dark grey and red lines).
Therefore, it should not be surprising that Allan Gray Australia analysts have been finding many of their ideas in the small and mid-cap space. Currently, 77.3% of the equity portfolio is invested in small and mid-cap stocks, versus 26.7% in larger holdings. Some examples of the Fund’s holdings include:
- Nanosonic: A biotech company that creates innovative materials using nanotechnology and polymer chemistry. It specifically focuses on a patented technology to disinfect medical probes.
- Ausnet Services: An Australian utilities company that delivers electricity and gas to households in Victoria, in the south-east of Australia.
- Austal: A global defence contractor and a designer and manufacturer of defence and commercial ships.
Many of these businesses have no counterparts in South Africa; these sectors simply do not exist locally. This is useful for South African investors looking to truly diversify their investment portfolios, as Allan Gray Australia not only provides country diversification, but also offers access to different and innovative industries.
Managing the risk of being contrarian
If you don’t hold most of the market constituents in your portfolio, it stands to reason that your performance will be very different from the index. This is reflected in Table 1, which shows that the Australia Equity Fund’s return profile has been quite different to the index over the last five years. Some investors see this as a risk and shy away from what is called ‘tracking error’ (a statistical measure of how much returns differ from the benchmark). As contrarian investors aiming to beat the market and create long-term wealth, tracking error simply is not a measure that we use to assess risk.
Perhaps the biggest risk for the contrarian investor is abandoning one’s discipline at the worst moment. Being contrarian can be very uncomfortable – the successful contrarian investor understands the importance of a consistent and focused approach, and investing with conviction. Our single-minded approach should offer the greatest comfort to prospective investors.
How to access Allan Gray Australia funds
The Allan Gray Australia Equity Fund is suitable for investors who are comfortable with market fluctuations and mentally prepared for the long time horizon (at least five years) required to take advantage of Allan Gray Australia’s contrarian approach. Investors looking for investment exposure to Australia, without taking on equity market risk, should follow the same approach as they would when picking a local fund, and look for funds that are not as exposed to the equity markets. The Allan Gray Australia Opportunity Fund seeks to invest in a combination of cash and shares and aims to beat the Reserve Bank of Australia cash rate.
Both the Allan Gray Australia Equity Fund and the Allan Gray Opportunity Fund are available via the Allan Gray Offshore Investment Platform and have been approved by the FSB for marketing to South African investors.