Contrarian and value investing strategies can generate incredible returns, as anyone who was buying up US equities in 2010 can tell you right now, but you sometimes get the feeling that analysts think dedicated value investors are a bit naïve.
“Many contrarian investors did very well in the financial crisis. The 2009-10 recovery trade offered them even more opportunities. We think it has always been cool to be contrarian, but sometimes it can also make you rich,” says a recent Citi report. Citi’s global strategy team argues that contrarian investment strategies are generally losing propositions, even though they outperform when the market turns, but they set up something of a straw man to prove their point.
Citi picks apart straw man contrarian strategy
“Our simple contrarian strategy buys the worst performing 10 stocks of the previous year and sells the best 10. The universe is the 250 biggest stocks from the MSCI ACWI as of December 2012,” they write. Citi does a thorough job of picking this strategy apart, the problem is that it’s hard to imagine someone actually investing this way.
Contrarian strategies need an underlying valuation method
Being contrarian doesn’t mean mindlessly betting against the consensus, it’s just understanding that the market can be extremely short-sighted and is prone to herd behavior. If you can afford to wait for a recovery (e.g. Buffett investing heavily in US equities after the financial crisis) or you just don’t think a stock price collapse is justified, then buying when everyone else is in fire-sale mode makes good sense. It’s not a matter of always thinking the market is wrong, it’s a matter of having faith in your own analysis, built on fundamentals instead of hype, and taking advantage of other people’s failure to do the same. That’s why contrarian investing and value investing aren’t busy strategies. Sometimes there just aren’t that many stocks that fit your criteria.
Citi’s ‘simple contrarian strategy’ misses on both counts. Since it doesn’t contain a valuation method, it can’t identify when a stock price is unjustified. Since it changes its positions once a year and every year, it isn’t able to swoop in during the transitions that best reward a careful contrarian investor.
