Just as all good things must come to an end, so, all bad things must too. But the trick to contrarian investing, according to a leading proponent on the global stage, Rupal Bhansali, is not to try to catch all falling knives. The CIO of Ariel Investments likes a neat turn of phrase.
Bhansali, who brings fundamental business values gleaned from her upbringing in India to her role as head of global and international equities for Ariel, peppered a presentation in Australia last week, the first since the Chicago-based firm opened its doors here this year, with stories about misunderstood sectors and stocks.
Ariel is a US$11 billion 32-year-old staff-owned and proudly minority-controlled fund manager which launched its only non-US office in Sydney in May with the recruitment of experienced marketer Ian Webber.
Bhansali said that Ariel’s style was to be business analysts first and foremost, then financial analysts and then stock analysts – in that order. By this she meant that the business model and fundamental business drivers behind the financials of a stock were the most important part of the analysis.
“Contrarian investors never pay full price,” she said. “We’re not distressed-sale investors either. We buy something when it’s on special, but not when it’s at a clearance sale.”
At the moment, there is almost a “fetish” for stability in equity markets which Ariel is looking to exploit. Bluechip consumer staples and certain utilities have become very desirable in the current climate, and therefore expensive. Stability trades at a premium, while volatility trades at a discount.
“We don’t own Apple but we do own some mega-caps,” Bhansali said. “One we own is Microsoft, which is a stock people love to hate. They think that Apple’s success comes at Microsoft’s expense, but that’s not true. Microsoft is an enterprise staple, it produces consumables. It has grown its earnings faster than that of Procter & Gamble… but P&G trades at a 50 per cent premium to Microsoft.”
Not all volatility was bad, just as not all stability was intrinsically low risk, she said. Overpaying for stability could result in underperformance or losses.
“The tipping point between risk and reward is valuations, not labels or perceptions of stability and volatility. Low valuations reduce risk while high valuations increase risk.”
In 2012, a lot of companies Ariel was looking at, because they fit the criteria, tended to be in Japan. So Bhansali went overweight Japan for the first time in her 25-year career, which paid off over the following two years. The firm has subsequently taken its profits.
“Our contrarian process is, in essence, that of independent thinkers,” she said. “We disagree with the market a lot.”
Ariel likes to study “second-order effects” for a stock in various scenarios, believing that markets are efficient in analyzing the first-order or direct effects of events but not so much down the line.
But there are some opportunities which are “under your nose” too. Verizon, the big US wireless provider is an example, trading on 12 times earnings [versus the market at about 17 times] with a 4 per cent dividend yield. “It has no international exposure, no currency risk, it’s a free lunch,” Bhansali said.
Ariel has also held Nokia since the global fund’s inception in 2011, because it believes the company’s intellectual property is undervalued. For instance, Apple pays royalties to Nokia for one of its pieces of smart phone technology.
“Nokia has been under-earning because it used to be a handset seller but now it’s not, so it can charge more for its patents. It can unlock something valuable. They’re currently in arbitration with Samsung and we see Nokia coming out ahead.”
In terms of thematic bets, Ariel has started to look at energy stocks because some “have just started to go on sale”. The firm believes that, over time, oil prices will go up because oil is the only commodity with a declining supply (unlike, say, iron ore or copper). The declining supply was especially so in unconventional energy such as fracking.
Webber told last week’s briefing in Sydney that super funds were considering Ariel’s global strategy as complementary to more traditional value or growth managers.
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