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Contrarian Investment
John Maynard Keynes was one of the world’s most successful investors.
The performance of Keynes’s Chest fund is shown below.
The Chest grew at an annual compounding rate of 9.1 percent while the general British stock market fell at an annual compounding rate of slightly under 1 percent. Given that the Chest fund distributed all dividends rather that reinvesting them, this is a truly exceptional performance.
Keynes described his investing philosophy as follows:
“It is the one sphere of life and activity where victory, security and success is always to the minority and never to the majority. When you find any one agreeing with you, change your mind. When I can persuade the Board of my Insurance Company to buy a share, that, I am learning from experience, is the right moment for selling it.”
The Uncomfortable Contrarian
Psychologically, a contrarian investment strategy can be uncomfortable.
You will be buying when the popular media is full of reports about how bad your choice of investment is. You will be selling when the media is celebrating the success of your investment, and no doubt predicting it will continue to perform well.
You can feel lonely when you’ve bought an unpopular investment; you hold it for what seems like forever until the price moves in your favor, and keeps moving in your favor.
Keynes’s biographer summarised his approach, saying, “He selected investments with great care and boldly adhered to what he had chosen through evil days.”
Investing With Great Care
The words “great care” are crucial. Don’t expect to become a successful contrarian investor simply by buying anything whose price has fallen. Typewriter stocks became unpopular a few years ago with good reason! Fortunately for IBM, however, some employees ignored their chairman, Thomas Watson, when he said in 1943, “I think there is a world market for maybe five computers”.
Selling
When you buy, you should buy with a selling price already in mind. You might express this price as a ratio. For example, you might enter the real estate market when the average home price to salary ratio is at 75% of its long term value with the idea of selling when it reaches 140% of its long term value. It’s up to you to look at the numbers and judge what’s appropriate. When you exit real estate, you should search for another market you can invest in that’s currently unpopular and underpriced.
The exit is crucial to contrarian investment. The underlying philosopy was nicely encapsulated by Ben Graham’s Mr Market in The Intelligent Investor:
Mr Market comes along each day quoting you a variety of prices for assets. He will buy or sell at the quoted price. Often his quotes are about right – they reflect fair value. Mr Market is, however, a manic depressive. On some occasions he is so down than he prices assets too cheaply. Other days he’s so optimistic that his quotes are much higher than fair value. The contrarian’s job is to buy from Mr. Market when he’s depressed and sell to him when he’s optimistic.
Waiting for the Price to Rise
It would be unfair to close this discussion without another quote from John Maynard Keynes:
“Markets can remain irrational far longer than you or I can remain solvent.”
