Offshore investing

Responding to challenging times

EXECUTIVE SUMMARY: Performance does not come in a straight line, which means that periods of long-term outperformance will always be accompanied by periods of, sometimes uncomfortable, short-term underperformance. History has shown that clients who have endured the tough periods tend to be well rewarded for their patience. Henry Allen and Trevor Black look at some of the factors behind Orbis' recent underperformance and provide some historical perspective on similar periods in the past.

The past year and a half has been challenging for Orbis - and frustrating for our clients. But it is critical to remember that periods of underperformance are an inherent characteristic of our contrarian approach to investing. They are part of our DNA as investors. Over the past two decades, there have been a number of occasions - sometimes painfully long - when our stock-picking decisions have caused us to lag the market and our peers. History has shown, however, that those decisions tend to be vindicated in the long run, and clients who have endured the tough periods have been well rewarded for their patience.

Unfortunately, that does not make it any easier to endure periods like the current one. Although our analysts are trained to be 'comfortable being uncomfortable', we do not expect our clients to enjoy watching their investments lag the market, or when compared to our competitors. As investors in our own funds, we think it is more important to focus on the consistency of the investment process over the long term. Orbis continues to follow the same investment philosophy and process that have worked for us for more than 20 years (an investment approach we share with Allan Gray). If there is just one thing that is consistent about every stock we hold, it is that we disagree with other market participants, and quite often with conventional wisdom.

We are also committed to being as transparent as possible. This means freely acknowledging our mistakes - and sharing our thought process with you in as much detail as we can. We cannot control how stock markets will behave, but we can ensure that you have the information you need to make considered investment decisions. This report will discuss some of the factors behind our recent underperformance and provide some historical perspective on similar periods in the past.

The last 18 months

Since 30 June 2009, the Orbis Global Equity Fund has risen by 25.6% while the benchmark has risen by 39.3%. In general, we do not believe there has been a common theme or area of geographic or sector exposure that explains our poor stock selection results. Rather, it is stock-specific across all regions, with the exception of continental Europe. That said, two areas merit further comment.

1. Global has had an exposure of 18% to Japan - on par with Europe and Asia ex-Japan
The Japanese stock market remains a disappointment. It has been flat over the past 18 months and is just 30% above its 27-year low of early 2009. Worse yet, the Fund's selections in Japan underperformed even the Japanese market - mostly due to its exposure to Japanese financials that raised capital below intrinsic value, and in doing so lowered per-share intrinsic value. These included SBI Holdings (an online broker), T&D Holdings (a life insurer) and Mitsubishi UFJ Financial Group (Japan's largest bank). Altogether, Global has 8% of its assets in Japanese financials, reflecting our belief that they continue to trade at large discounts to intrinsic value. In general, with market sentiment very depressed in Japan, we are finding many attractive long-term opportunities.

2. Global's relative performance has been hurt by having less exposure than the benchmark to the strongly performing Industrials, Basic Materials and Consumer Goods sectors
This is not unusual or necessarily undesirable: we do not seek exposure to every area that performs well, and we select stocks in a bottom-up manner with little concern for the composition of the index. Our quantitative analysis did not indicate that these sectors were especially cheap a year ago, and our bottom-up analysis did not uncover many compelling opportunities. Although being underweight these sectors has detracted from relative performance in the past year, and may continue to do so, we believe it is in the best long-term interests of our clients to have a larger exposure to other, more attractive areas of the market.

Orbis' success ratio

How does this compare to the past?

One of the toughest things about being a contrarian investor is that we are very often wrong. A professional investor who makes the correct decision 60% of the time can enjoy a long and fruitful career. This stands in stark contrast to almost any other profession. Would you go to a surgeon with a 60% success rate on the operating table? Or a lawyer who won only 60% of his or her cases? Amongst professional investors, contrarians make life even harder for themselves by swimming against the tide.

We accept these odds because the long-term rewards of this approach far outweigh the discomfort of being wrong in the short run. Although we do not have a crystal ball, our collective experience and analysis of market history tells us that the current period of underperformance is no different from anything we have seen in the past. To this end, our 'success ratio' should help put our investment philosophy and process in historical context. Simply put, although net alpha (outperformance of the benchmark after fees) is the final judge, the 'success ratio' is the proportion of the stocks in the portfolio which have outperformed the benchmark.
Looking at the success ratio can help to manage expectations about what is necessary in order to generate superior long-term returns. Graph 1 shows that even in our best year we got only 70% of the stock selection decisions right. It is worth noting that in the run-up to this period we had underperformed the World Index by 14% after fees for the year ended July 2000, the second worst separate 12-month period in our history. At that time, the five-year returns also trailed the index. The magnitude of our underperformance was exacerbated further by the fact that 'everyone else' was doing enormously well, with the average global equity fund outperforming the World Index by ±3%.

IF THERE IS JUST ONE THING THAT IS CONSISTENT ABOUT EVERY STOCK WE HOLD, IT IS THAT WE DISAGREE WITH OTHER MARKET PARTICIPANTS, AND QUITE OFTEN WITH CONVENTIONAL WISDOM

The anomaly of the average fund outperforming added insult to our clients' perceived injury. Sometimes the underperformance is because we are invested in ideas that have not come to fruition. In our worst year we got 70% wrong. Since inception, we got about six out of 10 decisions right - but this has been enough to generate satisfactory long-term returns. Although 52% of our ideas have missed the mark in the past 18 months, we do not view this as cause for alarm. Indeed, it is consistent with our historical performance record.

Transparency and consistency are key

During periods of underperformance, it is very tempting to change the way you invest. It is easy to conclude that something must be 'wrong' which requires an immediate fix. We have resisted this urge - and continue to invest the way we always have - because we think we can add value in the long term by sticking to what we do best. In the inevitable challenging periods along the way, we are committed to being transparent about our thinking and consistent in our approach. We believe this is ultimately the best way to serve our clients. 

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