A while ago I wrote a post here on the blog called Alla är vi värdeinvesterare, men vad är din edge? (that’s Swedish for: We are all value investors, but what is your edge?). My main point of argument was that everyone can be considered a value investor since we all expect a positive return on our investment, i.e. we would never buy something for more than we thought it was worth. What sets investors apart is their definition of value and in what ponds they fish for these values, i.e. where do they find their edge? In today’s post I thought I would continue to put my thoughts about investing philosophy into words but from a slightly different angle. What I thought I would write about today is the concept and importance of applying a ‘contrarian mindset’ in your investing philosophy but also how to apply it in an intelligent and financially sound manner.
The importance of being intentionally different
Wikipedia defines a contrarian as:
A contrarian is a person that takes up a contrary position, especially a position that is opposed to that of the majority, regardless of how unpopular it may be.
While I don’t think this is the complete definition you would want to apply to your contrarian investing mindset, more on that later, it is a good starting point for this blog post. This has to do with the fact that if you have chosen not to index you are, whether you like it or not, a contrarian. This notion splits the active investing population into two camps, the intentional contrarian camp and the unintentional contrarian camp. What sets the camps apart is whether the market consensus is an important factor in their investing philosophy.
Why is this important? No one has given a better explanation than Howard Marks on this point so why not use his explanation:
The price of a security at a given time reflects the consensus value. The big gains arise when the consensus turns out to have underestimated reality, or to have mis-estimated reality. To be able to take advantage of such situations, you must be able to think in a way that’s away from the consensus. You must think different and you must think better. It’s clear that if you think the same as everybody else, you’ll act the same as everybody else, and have the same results as everybody else. – Howard Marks
Note that Howard is not saying ‘different and right’, he is saying ‘different and better‘.
Superior performance does not come from being right, but from being more right than the consensus. You can be right about something and perform just average if everyone is right too. Or you can be wrong and outperform if everyone else is more wrong. – Howard Marks
The lesson from Howard is that we should try to invest in companies and situations where the consensus has developed disproportional payoffs between downside vs upside, i.e asymmetric bets. From this we also learn and understand that a good company does not in itself equal a good investment and that a bad company is not in itself equal a bad investment. Before we move on I would like to share a tweet that sums it up perfect:
Being different (a hipster-contrarian) is not enough
The word and concept of ‘contrarian‘ is nowadays almost as diluted as the notion of being a ‘value investor‘. I’m part responsible for this dilution myself since I have up until recently used the contrarian title to describe my investing style here on the blog and on twitter. The reason why I removed the title is not because I think less of the concept but rather that I have changed my opinion of how to apply it to my investing philosophy. I have to admit that my modus operandi when investing early on in deep value and special situations was that; the market must be wrong in these cases. I now consider this mindset not only stupid but I also relate it to the same mindset that a hipsters applies to his or her everyday life, i.e taking a standpoint that is different from the mainstream for the sake of it being different. Questions regarding why, efficiency and effectiveness is not in focus for a hipster and he or she will most likely leave her knitting (shortsightedness) as soon as it becomes mainstream.
A hipster-contrarian mindset therefore might cause you to end up with a portfolio that although different from the consensus/mainstream is still from an alpha seeking point of view completely wrong. In other words, being different is not enough. We also have to think better as Howard Marks puts it if we are to beat Mr Market. So how do we become a better contrarian then? The short answer is to develop a stoic-contrarian mindset.
How to become a stoic-contrarian
The first step of becoming a better contrarian and developing a stoic-contrarian mindset is to always question yourself; why I’m I right and everyone else wrong, might it not be the other way around? In order to successfully answer this questions the hipster-contrarian mindset has to evolve from applying a first-level thinking framework into a second-level thinking framework. A first-level thinking framework focuses on efficiency (doing things right) before establishing that what we are doing is effective (doing the right things). In his book The most important thing Howard Marks develops the concept of ‘second-level thinking‘. I think most of you have read the book so I’m not going to bore you with the original description (you can find that on Google) but instead show a short clip from one of my favorite comedy series where second-level thinking is brilliantly demonstrated and how we should apply it in order to developing a stoic-contrarian mindset:
The point I would like to make with the clip is that in order to be a stoic-contrarian we have to develop a second-level thinking framework like Phil Dunphy. That is, taking a step back and focusing on that we are doing the right things before we focus on doing things right. This is absolutely necessary in order to answer the why question earlier mentioned and establish that we are not fooling ourselves, i.e. thinking that we are taking a contrarian standpoint but we are actually not.
The first principle is that you must not fool yourself, and you are the easiest person to fool – Richard Feynman
The second step of becoming a better contrarian and developing a stoic-contrarian mindset has to do with improving your self-control and patience. Again, no one has a better explanation of why this is important than Howard Marks:
The more you try to be a superior investor, the more idiosyncratic positions you have to take. Invariably they will be unsuccessful for a while, and you will look worse, and the greater will be the pressures to succumb. – Howard Marks
You have heard it before and I’m going to say it again. There are no free lunches in investing. What you have to pay up for when trying to be a superior investor with idiosyncratic positions is a big portion of emotional and social distress. Buying things that everyone hates or never heard of is not easy, trust me. However, the good side of the equation is that the attractiveness of a stocks is dependent on the how much optimism is in the price. When people are optimistic prices are high in relation to value and when they are pessimistic they are low in relation to value. This is why taking a standpoint that according to the crowd makes you look wrong/stupid in the start will in the end be the only way to be right/smart.
In order to succeed in your self-control of emotional and social distress you have to have an investing philosophy that you believe in, a process that develops a courage in your conviction but maybe even more important; a big portion of patience. Patience does not only relate to investment cases that you have in your portfolio but also being comfortable with the bat steady on shoulder and seeing pitch after pitch go by. One of the hardest things to do is to sit still and even more difficult is to sitt still when other people are making big money. That is, taking yet another contrarian standpoint by not joining the crowd.
Practical hacks for developing a stoic-contrarian mindset
I realize that this approach to investing is not easy, at least I don’t find it easy. But as a very wise man once have said:
Investing is not supposed to be easy, and anybody who finds it easy is stupid. – Charlie Munger
However, there are daily life hacks that in my opinion helps tremendously in improving on the two steps of developing a stoic-contrarian mindset that I have talked about in this post:
- Look at share prices and your portfolio as infrequently as possible.
- Have a fixed number of investment decisions that you are allowed to do per month/year.
- Mediate on a daily basis.
- Read and seek worldly wisdom from all fields of science.
I hope you have liked this post and that it was to some form of use. If not I would still like to wish you all a happy Easter!