If you have seen The Big Short, the 2015 film adaptation of Michael Lewis’ book of the same name, you will remember the scene in which Michael Burry (played by Christian Bale) takes out his frustrations on his drum set.
We often talk about the idea of the contrarian – investors who “go against the herd” in order to take advantage of investment opportunities that others miss or ignore – but it’s an entirely different experience to be dropped into their shoes. This film was genius in its ability to explain how a few select contrarian investors were able to take advantage of the financial crisis of 2008, but it was equally genius in its ability to make us feel the pain and anguish of the contrarian.
The Asch Experiment
Social pressure is very real, as illustrated in the famous experiment on group conformity, directed by Solomon Asch in the 1950s. In the experiment (which has been repeated many times since), a participant is asked to run through a series of simple visual tests in a group format, comparing the length of a line on one card to the length of three lines on a second card, in order to discern which of the three options equals the length of the original line. The participant is unaware that all other members of the group are actors hired to purposely give the same, wrong answers. Initially, though confused and unsettled by the actors’ responses, the participant goes against the group, choosing what visually appears to be the correct answer. But as the experiment continues and more cards are presented, inevitably the pressure becomes too great and the non-actor conforms to group consensus. As this social experiment suggests, we innately are more likely to question the beliefs of one person (ourselves) rather than the beliefs of many.
Contrarianism as a Complement
We can all logically understand that, in order to beat the market, our investment portfolios must be different than the market. A contrarian viewpoint is imperative to long-term investment outperformance, and a complement to the investment process. While the investment process guides what we select for investment, the contrarian stance guides when we choose to invest. It is about making decisions that are supported by fundamental quantitative and qualitative research, and choosing a moment to act when others for various reasons miss the opportunity that the research has uncovered.
However (and rather unfortunately), being different, no matter the rational decision-making process, often forces us to feel gut-wrenching fear, frustration and doubt. It goes against our core nature as human beings. In order to stick with it over time we must have what Craig Pho, Portfolio Manager for Burgundy’s Asian equities, calls the “capacity to endure pain.”
The Capacity to Endure Pain
Craig has spent almost two decades uncovering quality companies in Asia, amid localized and global events that would scare away most investors. I look to Craig as one of the veterans in the “Pain Trade.”
Let’s unpack the idea. To have the capacity, I would argue it involves having both a willingness and an ability to endure the pain of being different.
To have a willingness means recognizing that short-term pain is inevitable for long-term gains. It means employing an investment philosophy with a contrarian stance (like Burgundy’s quality-value approach), maintaining awareness of that innate emotional human bias, and constantly monitoring investment decisions to ensure they come from a place of reason rather than emotion. It is a learned process, continually practiced with discipline, conviction and rigour.
To have the ability means having the space and time needed in order to be different. That space typically comes from the following stakeholders:
- Senior Management – Pain stems from the career risk that an investor takes when investing in an unconventional idea. Investment performance is very visible in this business and a poor track record will ultimately have consequences. Craig’s ability to look different than the benchmark in the short term over the years is due in part to the alignment and support of Burgundy’s senior management team, all of whom understand that contrarianism in the short term is a precondition for outperformance over the long term.
- Clients – While Burgundy is a discretionary investment manager (i.e., we make the investment decisions on behalf of our clients), it is critical to our daily operations that our clients consist of like-minded people who trust the process (and us). Portfolio managers like Craig are acutely aware that their decision-making puts that client trust to the test. Business and reputational risk are very real, which The Big Short was able to capture; recall the scene in which one of Michael Burry’s clients comes to his office to demand his money back! To maintain our clients’ trust, we stress the importance of alignment with our investment philosophy, and emphasize financial education before and after our clients choose to partner with us.
- Shareholders – If Burgundy was a publicly-traded company, we would need to weigh the interests of outside shareholders (who may not have an interest in the firm beyond short-term profits) against our clients’ long-term objectives. This is one reason why we tout independence as a critical component of our business. By maintaining our independence, our internal shareholders, consisting of more than two-thirds of the firm, act like owners of the business – because they are owners – and remain aligned with the long-term best interests of our client base.
Patience is a Virtue
As we’ve said many times before, buying low and selling high is a simple concept, but not an easy one to employ. In the words of Ben Graham, “In the short run, the market is a voting machine but in the long run it is a weighing machine.” By investing for the long term, we expect the weighing machine to inevitably recognize the true value of the quality companies in which we invest. In the meantime, it is our willingness and ability to endure short-term pain that affords us the time and patience needed to wait out the voting machine.
The Big Short movie still purchased from the Movie Stills Database. © 2015 Paramount Pictures, all rights reserved. Photo credit: Jaap Buitendijk.
Ben Graham quote sourced from The Essays of Warren Buffett.