Think Different, But Be Right


Rupal J. BhansaliThe CFA Institute Annual Conference is an unrivaled opportunity to access high-quality, unbiased educational content that equips investment professionals with the latest thinking on critical industry issues. The 71st CFA Institute Annual Conference will be held in Hong Kong on 13–16 May 2018.

Here’s a crazy idea: If you want to perform better than everyone else, start by doing something different from them.

This should be intuitive, but it’s not exactly easy. If clients are asking what you’ve done for them lately and your competitors are turning in great performances, it takes serious fortitude to stick to your special difference.

But the promise of such a strategy is significant, according to Rupal J. Bhansali, executive vice president and chief investment officer for global equities at Ariel Investments. While she says implementing such a process promises a stroll down the “path of most resistance,” I would be a little bit disappointed if that turned you off to the approach.

And the reason for that is simple: If you’re a professional investor, your job is to turn effort into alpha.

So you better work.

But there are things you can do to make your life easier. For starters, don’t waste time on looking into businesses that don’t meet one of your core criteria. Bhansali uses a process of elimination, screening out companies with unattractive characteristics so that an attractive opportunity set “rises to the top like cream over milk.”

Bhansali works to avoid investments that:

  • Are only optically cheap. This makes sense. As Bhansali says, “Markets don’t reward trading on information that everybody else has,” and headline metrics like P/E ratio are the poster children for information that everyone else has access to. Instead, derive a solid estimate for value based on the business itself.
  • Employ creative accounting. This doesn’t mean fraud. Bhansali focuses on avoiding “accounting chicanery,” which boils down to a business getting ahead of itself in its financial statements.
  • Derive returns from a low-quality business. We’ve all seen companies that are making money through a byzantine mix of macro tailwinds, cheap leverage, and dumb luck. Life is too short to try and make money there. As Bhansali says, “low quality businesses will compound your problems, not your returns.”
  • Have a weak balance sheet. Why take the risk? “Don’t forget, we are equity investors,” Bhansali says. “We are at the bottom of the cap structure. We have an option value in the business only if there’s something left over. If there’s nothing left over and debt holders claim a lot of the value of the company, then that option is worthless.”
  • Are likely to revert to the mean. Lots of businesses are cyclical, and at the top of the cycle there is always a hope that they’ve managed to change their fundamental nature.
  • Mules do not change into thoroughbreds. Channeling Henry Kissinger, Bhansali notes that “hope is not a strategy.”
  • Are about to be disrupted. Ignoring the competitive threat from a new potential entrant is a bit like hoping for a return to the flat world. Bhansali reminds us that “Amazon nixed brick and mortar. Shale fracking broke the nexus between oil and gas.” Don’t be casual about the risk that the world changes and leaves your favorite investment in the dust.

So what?

All of this is great advice, and the sort of thing that you might expect to hear about from a CFA Institute staffer. I like to think folks would be a little weirded out if we were suggesting paying attention to only headline P/E multiples and investing in companies that were about to be disrupted.

The crux of pulling off this process is the contrarian bit. As Bhansali notes, there is no payoff in seeing something that everybody else saw too. So instead, look for situations where the “bad news is priced in, but the good news is not.” This is easier said than done. Not only is it a hard problem for you, the analyst, to actually come up with a set of compelling ideas, it’s tough to get your clients to stick with you long enough to find out that your research was good.

On this, Bhansali had a really useful suggestion: “You need to tell people that what you are serving is fine dining, not fast food.” Remind them not to measure your performance after five minutes, since the meal won’t even be cooked yet.

And while you’re at it, you might remind them that eating nothing but fast food is a terrible long-term strategy.

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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.

Photo courtesy of W. Scott Mitchell

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