Value Investing

Absolute Return Partners Feb Letter: Challenging the Consensus

Absolute Return Partners February 2014 letter

” The noble title of “dissident” must be earned rather than claimed; it connotes sacrifice and risk rather than mere disagreement.”
Christopher Hitchens, Polemicist

Herd mentality is one of the strongest and most powerful human instincts. Humans take great comfort from walking the same path as others have walked before them, and nowhere is this more evident than in the field of investments. Most investors are simply incapable of disregarding the consensus when making investment decisions, if for no other reason than because ‘being out there on your own’ is associated with considerable career risk (I wrote about this back in October 2012 – see here).

I consider myself a contrarian investor. Not a contrarian for the sake of being a contrarian but a contrarian nevertheless. My inclination to go against the prevailing view is based on one very simple piece of knowledge acquired through 30 years of trial and error. When an investor states that he is bullish, he is more often than not close to being fully invested, hence he has used most, if not all, of his dry powder. Obviously, the more people who find themselves in this situation, the less purchasing power there is on an aggregate basis. At this point the market is at or near its peak. Precisely the opposite is the case when most investors are bearish. They have sold most if not all of their holdings, at which point the market is more likely to go up than down.

This way of thinking is frequently challenged by people (often academics) who argue that it cannot be that way, because investing is a zero sum game. We cannot all sell out at the same time, as someone has to own those bonds, or so the argument goes. Whilst theoretically correct, this view fails to take into account the distinction between core and marginal investors. Whilst marginal investors (e.g. private investors, hedge funds) can, and do, move freely between asset classes, core investors (e.g. pension funds, sovereign wealth funds) are at least partially restricted in their movements. Such limitations ensure that, in practice, investing is not a zero sum game.

Now, when I look at financial markets going into 2014, I cannot recall ever having come across a more one-sided view than the one which prevails. The consensus view on bonds is overwhelmingly bearish while pretty much everyone is bullish on equities – or at least they were until EM equities began to fall out of bed.

See Full PDF here: The Absolute Return Letter 0214

H/T PragCap

Absolute Return Partners