What is... | September 12, 2012

What is contrarian investing?

We know a contrarian is a person who takes a position opposite to that of the majority but what does it mean in investing? Contrarian investing – as the name suggests – typically involves taking financial positions that are opposite to that of the majority, such as investing in companies or sectors going through a difficult time.


Billionaire Warren Buffett is the most famous name linked with contrarian investing. But beware, this style of investing can be hugely risky, is not for the faint hearted and often only suits certain market conditions.

The opposite of investing with the herd
The idea behind contrarian investing is that an investor might outperform the markets – or an index of shares such as the FTSE100 – by taking positions that are not popular. An example cited in Michael Lewis’s book The Big Short is investors who went against the market ahead of the 2007 global financial crisis and effectively shorted United States mortgage derivatives, the US housing market and the collective wisdom of global financial institutions. While short selling has been criticised for adding to market turmoil, the contrarian investors in Lewis’s book used skill, discipline and deep pockets to make money on unpopular positions.
Contrarian investing can be extremely difficult and risky. Several of the fund managers highlighted in Lewis’s book faced severe losses before finally gained. Remember, like all investments, sometimes they pay off and sometimes they don’t.
Contrarian investing is the opposite of “herd investing” or “the conformity trap”, when investors get “caught up in the herd” and buy something because everyone else is buying.

Where are the bargains?
The efficient markets theory says that markets price in publically available information to give investments “fair value”. But ING global chief economist Mark Cliffe argues in Lesson 5 from the financial crisis that “the market isn’t always right”. He says greed and fear (and mass buying and mass selling) amid the crisis presented bargains for expert investors.
Contrarian investing comes into its own when the normal, efficient behaviour of the market breaks down and prices no longer necessarily reflect fundamentals. As such, contrarian investing tends to only suit certain market conditions rather than being a strategy to use any time.
Outperforming a broad based index of shares is difficult – especially when trading and other fees are included – hence the popularity of index-based, passive investment strategies rather than the active nature often associated with contrarian investing.

The Buffett effect
Billionaire investor Warren Buffett is considered by many to be a contrarian investor.
In Money (Art of Living) , hedge fund manager and author Eric Lonergan writes that the manner in which Buffett bought US shares in the 1970s and 1980s “was a bet on the survival of capitalism”. Arguably a contrarian position during that time of severe economic crisis.
Buffett’s fame and fortune is likely to feed interest in the investing style. But it just because the interest is there – and Buffett’s position paid off – it doesn’t follow that the investing style suits most people or most market conditions.

InvestingEconomics

eZonomics team
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