10/18/12 - great investments come by going against the crowd

In today's encore selection -- legendary investor Howard Marks contends that superior investment results can only come from going against the consensus. However, just because an investment is contrarian does not make it a good investment, it has to be the right contrarian investment -- and contrarian investing is by definition a highly risky and lonely pursuit:

"There's only one way to describe most investors: trend followers. Superior investors are the exact opposite. Superior investing, as I hope I've convinced you by now, requires ... a way of thinking that's different from that of others, more complex and more insightful. By definition, most of the crowd can't share it. Thus, the judgments of the crowd can't hold the key to success. Rather, the trend, the consensus view, is something to game against, and the consensus portfolio is one to diverge from. As the pendulum swings or the market goes through its cycles, the key to ultimate success lies in doing the opposite. ...

"The thing I find most interesting about investing is how paradoxical it is: how often the things that seem most obvious -- on which everyone agrees -- turn out not to be true.

"What's clear to the broad consensus of investors is almost always wrong. ... The very coalescing of popular opinion behind an investment tends to eliminate its profit potential. ... Take, for example, the investment that 'everyone' believes to be a great idea. In my view by definition it simply cannot be so.

  • If everyone likes it, it's probably because it has been doing well. Most people seem to think outstanding performance to date presages outstanding future performance. Actually, it's more likely that outstanding performance to date has borrowed from the future and thus presages subpar performance from here on out
  • If everyone likes it, it's likely the price has risen to reflect a level of adulation from which relatively little further appreciation is likely.
  • If everyone likes it, there's significant risk that prices will fall if the crowd changes its collective mind and moves for the exit."Superior investors know-and buy-when the price of something is lower than it should be. And the price of an investment can be lower than it should be only when most people don't see its merit. Yogi Berra is famous for having said, 'Nobody goes to that restaurant anymore; it's too crowded.' It's just as nonsensical to say, 'Everyone realizes that investment's a bargain.' If everyone realizes it, they'll buy, in which case the price will no longer be low. ... Large amounts of money aren't made by buying what everybody likes. They're made by buying what everybody underestimates. ...

"In short, there are two primary elements in superior investing:

  • seeing some quality that others don't see or appreciate (and that isn't reflected in the price), and
  • having it turn out to be true (or at least accepted by the market).

"It should be clear from the first element that the process has to begin with investors who are unusually perceptive, unconventional, iconoclastic or early. That's why successful investors are said to spend a lot of their time being lonely."


Howard Marks


The Most Important Thing


Columbia Business School


Copyright 2011 by Columbia University Press


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