On Contrarian Investing

You have likely heard us say that we are contrarian investors. This used to be a good way to differentiate ourselves from other investors. Increasingly, it seems to me that it has become quite common for investors to describe themselves as contrarian. On TV, the internet and in print, the term contrarian has become a fashionable label. Does that mean we no longer differentiate from the mass of active investment managers?

Many self-proclaimed contrarians insist that they will only invest in companies with above average returns on capital, rock solid balance sheets, a history of consistent earnings growth and free cash flow generation that are run by management teams that are not only shareholder friendly, but also superior operators. I have a name for businesses like these – “The Holy Grail.” In over 30 years as an investor, I have found it to be extremely rare for a company to embody each of these attributes and also be cheap. More importantly, there is no absolute definition of a cheap stock or of a high quality business. Instead there are many characteristics/traits that must be analyzed and weighed in relation to each other. The analysis must be considered with regards to historical context and current realities, not to mention the overall investment portfolio as a whole.

Contrarian investing most often means committing capital to companies that are unpopular and unloved. Often the only agreement among “experts” is that these are troubled companies or even bad businesses. The attributes of these companies are unlikely to meet all of the criteria of a purported “investor checklist.” Long ago, Benjamin Graham pointed out that these potential investments often share common qualitative traits, but the most commonly shared trait is that the majority of other investors think it is a poor investment.

Skechers (NYSE:SKX) provides a great case study of this. To say that the investment community held a unanimously negative view of Skechers at the time of our investment would be a major understatement. Only now that the company has worked through its problems, a fact that has not been lost on the market, has the widespread view changed to one that is almost unanimously positive. Securities are cheap because “the market” thinks the business is unappealing and/or permanently impaired. Sometimes this viewpoint is due to the assumed time horizon. We have found that the market’s definition of long-term has become increasingly shorter while our definition of at least 3 to 5 years remains unchanged. The goal of our analysis is to be able to view a company through a different lens than the rest of the market. Our experience is that great investment ideas arise from the times when our research and analysis lead us to a different conclusion than most others — a variant view. Very often, we find the market ends up agreeing with us down the road and we are able to reap the benefit of that disparity. The ability to understand the long-term dynamics that are necessary for the stock to not be cheap is as critical as determining the probability that those dynamics will unfold. Investing is more of an art than a science. Just as with painting there are common tools and accepted methods that one must master to be a great painter, but there is no one set of rules for how to paint a masterpiece.

We continue to reduce our position in Skechers as it has attracted attention and momentum has taken hold, both of which have impacted its valuation and risk/reward. The company has bounced back from its inventory issues and, as we expected, investors have shifted their focus to the core shoe business which has been performing extremely well. The stock is up over 200% from its lowest point, resulting in a decline in our margin of safety.

Investing in companies when everyone else thinks we are crazy, no one believes our thesis and the recent fundamentals do not conform to widely held views of what a successful investment idea should look like is what makes us contrarian. This is why our definition of contrarian investing has never changed no matter how popular the label has become and why it still differentiates us from most investors.

Successful investing requires an accumulation of wisdom and there is no shortcut for the time this accumulation requires.


The above commentary has been excerpted from the Robotti & Company letter for Q2 2014.

When Heirs Become Major Shareholders in Asia’s Family Business Groups: Accounting Tunneling or Valuation Takeoff?

The following article is extracted from the Bamboo Innovator Insight weekly column about the process of generating investment ideas among wide-moat businesses in Asia. Each month, an in-depth presentation on one such business is featured in The Moat Report Asia.

The silent but fierce battle to control one of Asia’s top family business groups with sales of over $80 billion and asset of $86 billion has intensified last week as two sons worked to become the handpicked successor of their patriarch father who turned 92 this October and who had underwent emergency surgery late last year after falling down.

Could this be a precursor to the succession and in-fighting risk that will take place in Asia’s family business groups which could override any advantages of the family model? Are there opportunities arising from capitalizing on the uncertainty surrounding the event?

Read more at The Moat Report Asia.

All-Star Investing

baseball-umpiresBaseball season is in full swing, so what better time than now to discuss the many similarities to investing, when my Los Angeles Angels of Anaheim – did I forget a city? – have the second-best record in baseball? Sorry I digress. Anyway, like investing, baseball offers strategy, statistics galore, multiple possible outcomes with probabilities to analyze, patience – it’s a long season – and a little bit of luck thrown in. See, just like investing.

I read an article in the New York Times last week about umpires. Title: Ball? Strike? It Depends: Is the Pitcher an All-Star? Hmm, the left side of my brain pondered. Why would that matter? Oh, yes, the right side replied. People. Bias. Human misjudgment. Follow the Crowd. Just like investing. In short, the subconscious mind prevails in certain situations and causes highly trained and experienced umpires to make an incorrect call.

Proof? The article cites two Northwestern Business School professors who studied data on 756,848 pitches over 313,774 at-bats in 4,914 games during the 2008 and 2009 seasons. Probably enough data to be “statistically significant” as the professors might say. The study adjusted for home team advantage, pitch count, right or left-handed batter, etc. The major findings include a bias in favor of All-Star pitchers and batters. A five-time All-Star pitcher had a 16% advantage over a non-All-Star in getting a ball called a strike. For batters the advantage was lower but still meaningful: a five-time All-Star had a 5-6% advantage in getting a favorable ball-strike call.

Other biases discovered included a slight bias to favor the home team. Perhaps umps, despite all of their training and outward ability to handle boos, deep-down simply don’t like to get booed by the home crowd. And in critical situations, such as near the end of the game, umpires were more likely to miss a call compared to very early in the game. Even hardened, experienced umps can be influenced subconsciously during pressure-packed situations.

The similarities with investing are obvious. Investors often favor the All-Stars when picking investments, buying Facebook, Twitter – or some Biotech company they’ve never heard of and don’t know what it does – but the stock could provide them with an early retirement, so let’s get in on it. And we humans don’t like to receive boos from the stock market, for example when we purchase a company and the share price declines, even though nothing much has changed with the company. Or during significant market declines, such as 2008-2009, when we allow the short-term pressure of crowd behavior or group think to influence our decision-making.

One solution is to be aware of our internal biases and confront them head-on. Recognize occasional imperfect behavior. Then develop an objective, rational process for decision-making (no different from many other areas of life).

Easy, right? OK, here are a few ideas. Stick to areas you know and understand. Follow 10 companies, not 100. Make your own decisions about whether an investment makes sense for you. Write down why you have made an investment – to help keep you on track when the investment environment becomes turbulent.

Like Major League umpires, investors are prone to make mistakes. But if we try and understand the conditions that lead to mistakes and consciously work to avoid them, we’ll have a much better batting average. Who knows, you might even be called an All-Star.


The above commentary is taken from The Misbehaving Investor, provided by Triad Investment Management.


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Other Risks for Fund Holders: Macro, Timing and Organizational Risks

In the second of a two-part article, we, Braun, von Wyss & Müller look at four more risks that a holder of fund units faces: the risk of macro-shocks, of us timing the market wrong and of us being incapacitated as a firm.

In the last article we discussed firm-specific risks and how we mitigate them by doing extensive research, buying at a large discount to the intrinsic value of the firm, being patient and diversifying. This article will cover four other risks that owners of any mutual fund run.

Macro Risks: big-picture crises

fund-risksMacro risks are risks that affect the economy as a whole, often but not always on a global scale. They are economic, such as inflation, credit crises, changes in interest rates and oil price shocks that hamper economic growth und thus the ability of businesses to make money. They nearly always include a political dimension and indeed are often rooted in political decisions. Current examples are the extremely low level of interest rates set by the Central banks, the Ukrainian crisis, an essentially local conflict with the potential to raise energy prices in all of Europe, and the Chinese government’s choices in the dilemma between stimulating the economy and averting a credit crisis.

Macro risks are very hard to anticipate. This is especially true when policymakers play a big role, because these people are usually acting under stress and for motives that are not always clear to an outsider. The Ukrainian crisis is an excellent example. It remains unclear how far Moscow will go in destabilizing the Ukraine and how the West will react. Could an economic war with the West cause gas prices to rise? And if they do, how much for how long? And what would that mean for Europe’s economy?

But even if a crisis is rooted largely in economic factors, such as the subprime crisis was, the many interdependencies in modern economies make it very hard to estimate to what extent the earnings of the companies in one’s portfolio may be affected. Who would have thought that the subprime crisis would lead to the bankruptcy of Circuit City Stores, the American electronics retailer in 2008? The company actually had quite a good balance sheet in 2007, but in the end, its suppliers refused to deliver goods on credit because Lehmann had failed, causing a crisis of confidence in the entire financial system. Similarly, it is very unclear if the pricking of the Chinese credit bubble will have ramifications outside the country.

The financial markets tend to reflect such risks quite fast with falling stock und (usually) rising government bond prices. Sometimes stocks decline slowly, sometimes they crash. It all depends on how many investors have chosen to sell within a certain period of time. But sometimes the market does not react even when a risk is well known, thereby signaling that most investors do not believe a bad outcome is probable. An example here is the discussions in December 2012 in the US Congress about raising the debt ceiling, which hardly affected stocks, clearly because everyone expected a last minute compromise – quite rightly, as it turned out.

Under such circumstances hedging costs are low, and we will sometimes buy index puts on the portfolio, using pretty much the same logic as that of a buyer of fire insurance on his or her home. One does not expect the house to burn down but buys protection anyway.

However, please do not expect us to hedge in most cases. We concentrate on the analysis of individual companies, because even experts are unable to forecast macro risks and their consequences with any reliability. That means you must expect our funds to drop with the market when it crashes. They will sometimes even drop more, because we own some companies that do not have excellent reputations or are simply small, making them first candidates for sale when panicked investors want to raise cash. However, our stocks should survive such a shock and outperform in the medium or long term, because they are undervalued and solidly financed (see our blog entry from June 24, 2014 “Risks and how we handle them” ).

Timing Risk: buying and selling at the wrong moment

The prices of stocks usually follow their intrinsic values, but not always. Market manias and panics that sweep all stocks or just some sectors can cause prices to deviate from these intrinsic values, and an investor is at risk of getting caught up in the frenzy or the gloom. That means buying high and selling low, thereby creating permanent losses (see our blog entry from Dec. 20, 2013 “Cognitive biases and managing one’s career: why value inveting works” ).

Value investing is the protection against this risk – it obviates the timing question. When a stock is 30-40% below intrinsic value, it is by definition a good time to buy, provided that the intrinsic value estimate is sound. Similarly, selling at intrinsic value keeps one from participating in manias and exposing oneself to their inherent risk of sudden and permanent loss when the euphoria ends.

Organizational risk: the fund manager is incapacitated

There is always a possibility that an asset management firm ceases to function as hoped, for example because the key employees are killed.

This is the last risk you need worry about, because if something happens to Thomas Braun and I, our team of employees is capable of running the portfolio as we do. All of them understand and are absolutely committed to the discipline of value investing, and together they are familiar with all aspects of running the funds. And for as long as Thomas Braun and I are still managing the portfolio, our colleagues are watching our every move very carefully – and believe us, they are not shy of pointing out things they think are wrong, because almost all of their money, too, is tied up in the funds. Our colleagues are our most critical clients.

There are also other risks, for example an IT problem or a fire in our offices. We mitigate these risks by backing up all of our data in various ways, including an off-site backup of our research and portfolio management files. While these measures do not guarantee a seamless continuation of our work from hour to hour, even in the very worst case we should be able to continue managing the funds and following our positions from our homes within a day or so. In the meantime, not much of consequence can happen to the funds. They are safe in the hands of our custodian, the Liechtensteinische Landesbank (LLB) in Vaduz. At worst we miss an opportunity to make an investment decision because we at BWM AG are busy reorganizing ourselves.

Counterparty Risk: Custodian failure

Theoretically, our custodian bank, Liechtensteinische Landesbank, could fail. That risk truly is highly theoretical, as the bank’s controlling shareholder, the Principality of Liechtenstein, carries a AAA rating from the rating agenices, the highest possible. But if it did happen, what would be the consequences? It depends on the amount of cash deposits that we have with LLB at the time. That would be the only asset at risk, as it would fall into the bankruptcy estate. The rest of each fund’s holdings are securities held in segregated accounts that would remain in the possession of the fund unit holders even if LLB was wound up. And of course a bank with a conservative business model like LLB’s would not go bust overnight. Its financial position would take some time to deteriorate, allowing us to make other arrangements for holding our cash, for example by parking cash in bonds of the Swiss Confederation.

Next month we will cover a false risk that stands in for equity risk: volatility. We will show how nonsensical it is for the equity investor to worry about it.


The above post was originally published on the blog of Braun, von Wyss & Müller.

Commentary on LifeLock (LOCK)

LifeLock is a consumer services company that sells identity-protection alerts to children and adults across the country. The benefits of a LifeLock subscription are, in our view, dubious at best, and the company’s history is littered with allegations of questionable business practices and personal misconduct. After the recent news that LifeLock failed to implement very basic data security standards, the company’s brand and growth rate are potentially at issue.

The company is exceptionally promotional, spending nearly half of its revenue on marketing and advertising. You may remember the ads that the CEO placed in many newspapers a few years ago displaying his real Social Security number. (Unfortunately for him LifeLock didn’t work and his identity was stolen more than a dozen times.) LifeLock may also be in violation of a prior FTC consent order regarding allegations of false advertising.

We recently reduced our position significantly when the price crashed on news of the aforementioned data security problem. (Incidentally, the lapse occurred at a subsidiary acquired in late 2013 for $42 million despite negligible revenue, a $5 million annual operating loss, and a recent history of using very expensive corporate debt to buy Bitcoin in a private transaction with the CEO; it sold the Bitcoin back to him a few months later for a gain of approximately 36%.)

The most compelling argument I can find regarding the company’s prospects is that identity theft is scary, and consumers do especially dumb things when they’re scared. The sky-high valuation certainly incorporates rapid and continuous growth along those lines. As with many short ideas, however, the ride has been and will likely continue to be bumpy – this year the stock price went from under $16 to nearly $23 before crashing to $11 and since recovering to $14.


The above commentary is excerpted from the 2Q14 quarterly letter of Anabatic Fund, L.P., dated July 15, 2014. The fund’s portfolio manager is Philip C. Ordway, a principal of Chicago Fundamental Investment Partners, LLC. Please note that the complete text of the disclaimer included with the fund’s quarterly letter is also reproduced below.

THE INFORMATION PROVIDED HEREIN IS CONFIDENTIAL AND PROPRIETARY AND IS, AND WILL REMAIN AT ALL TIMES, THE PROPERTY OF CHICAGO FUNDAMENTAL INVESTMENT PARTNERS, LLC, AS INVESTMENT MANAGER, AND/OR ITS AFFILIATES. THE INFORMATION IS BEING PROVIDED SOLELY TO THE RECIPIENT IN ITS CAPACITY AS AN INVESTOR IN THE FUNDS OR PRODUCTS REFERENCED HEREIN AND FOR INFORMATIONAL PURPOSES ONLY.

THE INFORMATION HEREIN IS NOT INTENDED TO BE A COMPLETE PERFORMANCE PRESENTATION OR ANALYSIS AND IS SUBJECT TO CHANGE. NONE OF CHICAGO FUNDAMENTAL INVESTMENT PARTNERS, LLC, AS INVESTMENT MANAGER, THE FUNDS OR PRODUCTS REFERRED TO HEREIN OR ANY AFFILIATE, MANAGER, MEMBER, OFFICER, EMPLOYEE OR AGENT OR REPRESENTATIVE THEREOF MAKES ANY REPRESENTATION OR WARRANTY WITH RESPECT TO THE INFORMATION PROVIDED HEREIN. AN INVESTMENT IN ANY FUND OR PRODUCT REFERRED TO HEREIN IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. THERE CAN BE NO ASSURANCE THAT THE INVESTMENT OBJECTIVE OF ANY SUCH FUND OR PRODUCT WILL BE ACHIEVED. MOREOVER, PAST PERFORMANCE SHOULD NOT BE CONSTRUED AS A GUARANTEE OR AN INDICATOR OF THE FUTURE PERFORMANCE OF ANY FUND OR PRODUCT. AN INVESTMENT IN ANY FUND OR PRODUCT REFERRED TO HEREIN CAN LOSE VALUE. INVESTORS SHOULD CONSULT THEIR OWN PROFESSIONAL ADVISORS AS TO LEGAL, TAX AND OTHER MATTERS RELATING TO AN INVESTMENT IN ANY FUND OR PRODUCT.

THIS IS NOT AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY AN INTEREST IN A FUND OR PRODUCT. ANY SUCH OFFER OR SOLICITATION WILL BE MADE ONLY BY MEANS OF DELIVERY OF A FINAL OFFERING MEMORANDUM, PROSPECTUS OR CIRCULAR RELATING TO SUCH FUND AND ONLY TO QUALIFIED INVESTORS IN THOSE JURISDICTIONS WHERE PERMITTED BY LAW.

ALL FUND OR PRODUCT PERFORMANCE, ATTRIBUTION AND EXPOSURE DATA, STATISTICS, METRICS OR RELATED INFORMATION REFERENCED HEREIN IS ESTIMATED AND APPROXIMATED. SUCH INFORMATION IS LIMITED AND UNAUDITED AND, ACCORDINGLY, DOES NOT PURPORT, NOR IS IT INTENDED, TO BE INDICATIVE OR A PREDICTOR OF ANY SUCH MEASURES IN ANY FUTURE PERIOD AND/OR UNDER DIFFERENT MARKET CONDITIONS. AS A RESULT, THE COMPOSITION, SIZE OF, AND RISKS INHERENT IN AN INVESTMENT IN A FUND OR PRODUCT REFERRED TO HEREIN MAY DIFFER SUBSTANTIALLY FROM THE INFORMATION SET FORTH, OR IMPLIED, HEREIN.

PERFORMANCE DATA IS PRESENTED NET OF APPLICABLE MANAGEMENT FEES AND INCENTIVE FEES/ALLOCATION AND EXPENSES, EXCEPT FOR ATTRIBUTION DATA, TO THE EXTENT REFERENCED HEREIN, OR AS MAY BE OTHERWISE NOTED HEREIN. NET RETURNS, WHERE PRESENTED HEREIN, ASSUME AN INVESTMENT IN THE APPLICABLE FUND OR PRODUCT FOR THE ENTIRE PERIOD REFERENCED. AN INVESTOR’S INDIVIDUAL PERFORMANCE WILL DIFFER BASED UPON, AMONG OTHER THINGS, THE FUND OR PRODUCT IN WHICH SUCH INVESTMENT IS MADE, THE INVESTOR’S “NEW ISSUE” ELIGIBILITY (IF APPLICABLE), AND DATE OF INVESTMENT. IN THE EVENT OF ANY DISCREPANCY BETWEEN THE INFORMATION CONTAINED HEREIN AND THE INFORMATION IN AN INVESTOR’S MONTHLY ACCOUNT STATEMENT IN RESPECT OF THE INVESTOR’S INVESTMENT IN A FUND OR PRODUCT REFERRED TO HEREIN, THE INFORMATION CONTAINED IN THE INVESTOR’S MONTHLY ACCOUNT STATEMENT SHALL GOVERN.

NOTE ON INDEX PERFORMANCE

INDEX PERFORMANCE DATA AND RELATED METRICS, TO THE EXTENT REFERENCED HEREIN, ARE PROVIDED FOR COMPARISON PURPOSES ONLY AND ARE BASED ON (OR DERIVED FROM) DATA PUBLISHED OR PROVIDED BY EXTERNAL SOURCES. THE INDICES, THEIR COMPOSITION AND RELATED DATA GENERALLY ARE OWNED BY AND ARE PROPRIETARY TO THE COMPILER OR PUBLISHER THEREOF. THE SOURCE OF AND AVAILABLE ADDITIONAL INFORMATION REGARDING ANY SUCH INDEX DATA IS AVAILABLE UPON REQUEST.