Interview with Julian Morrison by Zilla Efrat
Human nature can be our own worst enemy when investing, according to Allan Gray’s National Key Account Manager, Julian Morrison.
One reason, he says, is because people tend to go with the pack and believe the hype.
In life, Morrison says it often makes sense to go with the crowd. For example, if you’re an engineer, you’d want to follow the consensus on what’s best practice in safe bridge design. And, when dining out, you’d probably want to eat in a restaurant with a good rating on TripAdvisor.
But this usually doesn’t work with investments; it’s probably better to do the exact opposite.
“People get overexcited about a positive story and suddenly everyone is competing against each other to buy a certain share, and they bid up the price to unattractive levels,” says Morrison.
“Everyone is buying on the same expectations and if they are correct, that probably won’t help them a great deal because those expectations are already built into the price.
“People may have ‘won at the auction’, but they are likely to have overpaid for that share and potentially risk a permanent loss of capital. They may have bought a brilliant company that’s profitable, but if the price is too high and doesn’t represent the company’s fair value, the market will recognise it sometime in the future and the share price will revert to fair value.”
What goes down comes up – doesn’t it?
‘Permanent loss of capital’? Surely the share price will rebound in the future? Not necessarily, according to Morrison.
He says: “Look back to the tech boom around the turn of the century and take a share like Cisco Systems. Its share price today is about half what it was in early-2000. And if you had bought Microsoft in late-1999, you would have waited 15 years until late-2014 for it to return to the same price.
“Yes, you can overpay and still get your money back eventually, but you also have to think about how inflation will have eroded your investment over that time. There is also an opportunity cost.”
Beds are for sleeping, not for banking
Other human “flaws” revolve around the way people view risk and allow this to affect their decision-making.
Morrison says: “They may take on too much risk because their expectations are too high or because they are overconfident and see less risk than there actually is. Conversely, they may not take on enough risk, especially if they have lost money before.”
He points to former Canadian ice hockey champion Wayne Gretzky who said: “You miss 100 per cent of the shots you don’t take.”
“You can put your cash under the mattress and know for a fact that as long as your house doesn’t burn down, you will have that cash in 10 years’ time. But what that cash will be worth after inflation is another matter.”
It’s human nature to panic when a share price falls, and capitulate when opportunity may be greatest. It can also be tempting to buy more of an asset that’s already risen a lot.
But Allan Gray believes successful investing can be counterintuitive and it has developed an investment philosophy that is contrary to human nature.
Firstly, it never runs with the pack.
“For us, the more competition you face, the worse the likely outcome,” says Morrison.
“We prefer to buy when everyone else is selling. And if a share falls further, we revisit our original valuation and the reasons we invested in it. If that’s unchanged, we will often buy more.”
This concept is not new. As Morrison notes, contrarian investing has been around for hundreds of years. “It’s the basic idea of buying something when it’s cheap and in a less optimistic environment and then selling it when things are more positive,” he says.
“But behaviourally, that doesn’t feel comfortable. It requires huge discipline and confidence and you can’t build that overnight. We rely on three elements to help build this.
“The first is time. At Allan Gray, our confidence comes from experiencing many cycles. Our people understand that often the most challenging time for a share provides us the greatest opportunity to buy it cheaply.
“Next is understanding. Our internal evaluations of the company and our belief in its fundamental strengths can also build our confidence. If the company has more reliable, or valuable, underlying assets, you have a greater buffer in the event of future challenges.
“Finally, it’s about the people we hire. They’ve usually done something exceptional in their careers, but don’t have a background in funds management. They are often from a hard science background and are able to think in terms of probability. They search for the small amounts of useful, factual information, in an ocean of conjecture.”
Morrison adds that it’s also vital to have conviction and patience.
“We look to underpay as much as we can for a share and are prepared to wait until things improve. Alternatively, we may have identified a company that we like, but it may not be cheap enough, so we will have to wait until circumstances change and the price falls.
“It sounds easy, but in the heat of the moment, stepping back and having discipline is very hard for most people.”
Still, Morrison concedes, things don’t always turn out the way Allan Gray expects. “But we have outperformed the market over a long period to date. And, if we apply our approach consistently, we believe it should be possible to perform well in future – in large part due to the persistence of human behaviour.”
Julian Morrison holds a Bachelor of Arts (Honours – University of Sheffield) and the Chartered Financial Analyst designation.