Although he is credited with its invention, Alexander Graham Bell refused to have a telephone in his study, fearing that the noise and distraction would take him away from his scientific work. His ability to focus and avoid distraction led Alexander Graham Bell to his many remarkable insights about sound. His mother’s loss of hearing influenced his immediate family and after many years of teaching speech and vocal physiology, in 1847, the essential idea of the telephone formed in his mind. His single-mindedness about transmitting sound electrically led to him being able to send more than one telegraph message over the same wire at the same time. This was the key insight that helped establish the telephone. He then went on to establish a school for the deaf, played an active role in the development of various devices to help deaf people learn to speak, and found a way to graphically record sound waves.
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The extent of the ‘noise’ in investment markets today leaves us with the same challenge. If we are not mindful, and disciplined, we could make the mistake of being complacent and focusing on the points that are most vivid and oft-repeated. A popular view drives prices up and an unpopular view drives prices down. But like Bell, our contrarian approach requires us to be single-minded and focused; and avoid the distraction of the market’s fickle view.
Folkestone Education Trust: the benefit of seeing childcare centres differently
Allan Gray first bought shares in the Folkestone Education Trust (FET), formerly known as the Australian Education Trust, for the Allan Gray Australia Equity Fund towards the end of 2007. FET was an owner of the land and buildings that housed childcare centres throughout Australia. It looked good on paper – a high dividend yield, growth above inflation and very favourable lease terms. The units appeared cheap because the market was pricing in a stumble by their only tenant who was facing financial difficulties having taken on too much debt to fund a series of acquisitions.
Investors sell aggressively because the future looks bleak
The worst-case scenario did happen: FET’s only tenant went broke and the market reacted by discounting the value of the Trust’s units even more. In fact, the units lost more than 90% of their value quickly. This was a true test of our investment conviction and patience at the time.
Most people sold units due to the considerable risk and a lack of near-term earnings. Without a tenant, FET could no longer boast safe and growing dividends, which meant many yield-hungry investors sold.
The ensuing panic created a great opportunity for a patient investor
We therefore added a large number of units to the Fund’s portfolio as the price fell. Although the tenant was bankrupt, we believe childcare is an essential service that would continue to be supported by the government. This would enable other childcare operators using FET’s assets to be profitable. Moreover, the land value accounted for at least half the value of the Trust, which gave us some measure of downside protection.
Investors now appear to be very confident of future returns in the childcare sector
The childcare industry has since turned a corner and the value of most parts of the industry has increased substantially since those very dark days. FET’s units have recovered more than their value and have paid healthy dividends for a few years. As contrarian investors, we proactively look at things from many different perspectives, and tend to avoid paying attention to the popular view in our search for value. We have therefore taken the opportunity to trim our exposure to FET in favour of other companies and industries that are currently unpopular. We have done so for our committed long-term investors to reap the rewards of a portfolio that is different by design.