Interview with Julian Morrison by Lachlan Colquhoun

The majority of investors on the Australian Securities Exchange will hold the shares they buy for around 12 months.

It is a pattern of investing which is not only short-term, but leads to a herd mentality where small dollops of good and bad news are magnified and distorted.

This knee-jerk buying and selling is driven by sentiment and not by a disciplined or rational approach.

In this market, investors tend to buy when prices are high and sentiment around a stock is buoyant.

Or, as has happened in recent years, investors buy stocks largely for the dividend income they will provide.

A different approach to investing

“Many people are saying ‘I need an income of $50,000 how many shares in Bank X do I need to buy to achieve this,’” says Julian Morrison, National Key Account Manager at investment firm Allan Gray.

“This is often irrespective of whether they are overpaying for the shares in terms of a reasonable valuation.”

At Allan Gray, the investment team take a different and more rational approach to investment.

They take a much longer-term view of shares, and consciously avoid the market darlings of the moment in favour of stocks which are undervalued and even out of favour, but which they believe will deliver returns over time.

“To use a real estate analogy, we want to go to the auction where there is no one else bidding for the property,” says Morrison.

“If there are 50 people bidding we are going to pay a very high price to jump to the front of the queue.

“Of course you need to very clearly understand the issues – why no-one else is there bidding. If you don’t you could be buying a dud. But for most companies, like most properties, there is a price at which they are a bargain. If you can assess this rationally while others overreact to short-term news, in the long run you can do very well indeed.”
Rational vs Irrational.Blog Edit.16.05.26

The greater the stretch, the greater the snapback

Looking at the Australian sharemarket in 2016, Morrison says it is in an “extreme” situation, where market winners have continued to win and losers have continued to lose for an extended period of time.

Banks, healthcare and the real estate investment trusts have been the winners over the last few years, while resources, the consumer sector, and generally cyclically-exposed companies have continued to fall from favour.

The Allan Gray approach is to look at those out–of-favour companies to try and find shares which are good value and which they believe are likely to rebound.

“You can think of it as an elastic band,” says Julian Morrison.

“The more you stretch, the greater the snapback will be.”

Taking a five year view rather than a one year view gives these “out of favour” stocks time to rebound and deliver profits to investors.

“Even if the company’s operating performance is merely average, rather than bad, you can make good money,” says Morrison. “The share price rises when the actual outcome is not as bad as expected.”

“Alternately, if something has been going brilliantly the price is high, but if the future turns out to be merely good rather than fantastic you can still lose money because results didn’t meet expectations and the share price has further to fall from its overvalued levels.”

When irrational selling creates opportunity

Allan Gray will often look at out-of-favour companies that have just dropped out of well-followed market indexes.

In this situation, investors who track the index will be obliged to sell the stock, and many other so-called “active” investors will also sell because of the wave of negative sentiment, and also because many are not willing to deviate too far from the index.

For Allan Gray, however, these stocks represent opportunity because their falling share price has not been driven by rationality, but by a knee-jerk short-term response.

“Our bread and butter is things which were formerly big but have fallen on hard times and are cyclically down,” says Morrison.

“Where we see irrational selling we see opportunity.

“The one thing that people can do is what most people do not do, and that is take a rational and truly long term view and that can give you an edge.”

 

Julian Morrison holds a Bachelor of Arts (Honours – University of Sheffield) and the Chartered Financial Analyst designation.