Value Investors Fighting the Urge to Herd


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Early in 2016, investors in Valeant Pharmaceuticals rushed for the exits after the company slashed its revenue and earnings outlook and warned that a delay in filing its annual report put it at risk of default on its $30 billion in debt. The company’s stock, widely-held by the $3 trillion hedge fund industry, lost more than half its value in one day. The fall-out was far-reaching, adding to the performance woes of celebrated stock-pickers and underscoring the growing correlation between hedge fund managers, attributable (at least in part) to their propensity to crowd into the same stocks.

Herding, the propensity of individuals to mimic the actions of their peers, is among the most impactful investor biases in behavioral finance. It regularly manifests itself in the form of market extremes, both bubbles and crashes. And while it remains an instinctive act of self-preservation in the animal kingdom, herding ill-serves investors and is precisely what investors pay professional fund managers to avoid. Indeed, the most successful fund managers are contrarians — those who zig when the market zags.

Sir John Templeton, recognized as one of investing’s greatest contrarians, is credited with saying, “To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward.” Fellow contrarian Warren Buffett struck a similar chord when he advised, “Be fearful when others are greedy, and be greedy when others are fearful.” So, why do so many fund managers play it safe by hugging an index or crowding into the same stocks owned by their peers?

Following the consensus, it must be thought, is a sure-fire way to mitigate career risk — particularly for those who lack skill, and evidence suggests that there’s an abundance of unskilled laborers in the hedge fund business. In 2012, hedge fund critic Simon Lack noted that “If all the money that’s ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good.” And yet hedge fund investors, by definition a sophisticated lot, can’t seem to resist the allure of aligning themselves with high-profile trend-following managers. More often than not, their herding leads to mediocre performance, or worse. Investors would do well to instead look for a fund manager who takes a long-term perspective and isn’t afraid to challenge the prevailing wisdom.

Patience and a willingness to go against the crowd are hallmarks of successful value investors. Rupal J. Bhansali, chief investment officer of international and global equities at Ariel Investments, is one such investor who bears watching. In the two decades since she began her investing career working for George Soros, Bhansali has established herself as a leading value investor; her contrarian bona fides are unquestionable. Bhansali’s emphasis on risk management helps to set her apart from her peers, and she draws the important distinction between risk — the permanent loss of capital — and volatility, noting that “volatility is the friend of the long-term investor and the enemy of the short-term investor.”

At the 69th CFA Institute Annual Conference, Bhansali shared insights into her own brand of contrarian value investing, helping other investors who are looking to resist their urge to herd.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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