04 May 2010 | Opinion

Going Against The Flow - Choosing Investments 

Robert O’Riordan on the importance of knowing when to take your own initiative and break away from the crowd.

Some children are just downright difficult. If you say black, they’ll say white. If everyone else has stopped, they’ll want to carry on. Some even have the nerve to argue with their elders and betters who must then resort to time-honoured diktat such as ‘because I say so’ and ‘who said life is fair?’

However, such stubbornness and contrarianism may have their place when choosing investments. The trick is to know when it is best to stick to your guns or when it is better to silently and stealthily abandon a position. Just as parents are advised to ‘pick the right battles’ (those they have a chance of winning), so successful investors must have the knack of distinguishing between lost causes and unrecognised worth.

But markets are, by their nature, rather complicated. They represent the expression or investment views of all participants, and in choosing to buy, sell or hold a share, every individual (in theory) has an impact on a market. Those with larger holdings may have a proportionately greater impact on the share price, but the combined power of many small investors should not be underestimated. In illiquid markets, when buyers and sellers meet infrequently and trade only a few shares, those buyers with the swing vote, perhaps only a relative few, can have disproportionate power.

Efficient market hypothesis states that, when assets are traded in organised markets, prices take account of all the available information. Thus it is impossible to predict whether some assets will give better risk adjusted returns than others, because the returns depend on news that is not yet available.

This is fine in theory, but in practice if everyone is facing one way, it could make sense to take the contrary position and turn around to face the opposite direction. On top of this, it may be worth remembering that the market is a discounting mechanism. While a company may have fantastic prospects and attributes, if everyone and his wife knows this, there may not be much to go for in the future. Conversely, a good time to befriend a share may be once it has become a pariah. In essence, there may be no hard and fast rules in investment, except perhaps that every rule has its exception. Another favourite game rule is that the only rule is that there are no rules.

Sometimes there is a good reason why everyone is running in one direction; and to blindly run into the abyss may not make sense. Challenging the majority or consensus view in an intelligent and determined way can be fruitful. It is hard to imagine anyone putting this more elegantly than the legendary American investor Warren Buffett. In a recent piece in The New York Times, entitled Buy American, I Am, he reiterated one of his favourite maxims, ‘Be fearful when others are greedy and be greedy when others are fearful’. But remember, just as with that contrary or argumentative child, a tolerant but sceptical question or response to the market may yield positive results.

The views expressed are the author’s and are not recommendations or advice and no reliance should be placed on them when making investment decisions. Stock market investments can fall as well as rise and investors may not get back the amount invested.

Author: Robert O'Riordan
Robert O’Riordan is responsible for liaising with investment trust boards at Baillie Gifford and for communications with shareholders.