Offshore investing - Allan Gray
Offshore investing

Things you can control, and things you cannot

EXECUTIVE SUMMARY: In this current very uncertain world, we cannot begin to control or predict political or economic outcomes. But we can control what shares we buy and we are acutely aware of the price we pay for them. Jonathan Brodie and Trevor Black, from our offshore partner Orbis, discuss how instead of trying to control the uncontrollable, Orbis and Allan Gray work hard to find stocks that look compelling, analyse them in the context of a consistent philosophy, and build a concentrated portfolio of the best ideas.

We can be certain that the world will always be full of uncertainties – and the last few years have confirmed this fact. From European deleveraging, austerity and fears that the euro dream is falling apart to concerns over a possible hard-landing in China, Japan’s continuing moribund economy and dysfunctional politics in the US, investors can find little source of comfort. In such an environment, many investors prefer to take refuge in cash, but even that does not provide much comfort when the world’s major currencies are questionable long-term stores of value and interest rates are likely to be negative in real terms.

Being bottom-up stock pickers does not shield us from uncertainty – the stocks we pick operate in the same difficult universe. But our approach is somewhat different. We do not try to predict the macro outcomes because we do not think we can add value that way. Rather than trying to bet on how the big problems might play out, we focus on finding specific companies that we think offer compelling opportunities to enhance our clients’ capital – even in the face of difficult macro problems.

In the current environment, and this is true in all environments, we need to search long and hard for specific ideas where we can develop conviction; we spend most of our time rejecting ideas. There are roughly 7 800 eligible stocks in our universe. In 2011 our analysts studied approximately 580 of them, and the Global Fund invested in around 15 major new positions, or well under one big idea per analyst. In essence, we are asking each analyst to uncover one great idea per year. Critically, to find that great idea, they have to look at many others. A lot of them will be suitable, and some will be good, but very few will inspire a high enough level of conviction for capital to be committed.

It is an uncertain world and we cannot control the behaviour of politicians, overall investment decision-makers, consumers or stock market pundits. But we can control which shares we buy and we are acutely aware of the price we pay for them. Before we buy any share, we analyse the businesses in depth, assessing its competitive position, suppliers, customers and financial circumstances. We constantly look for specific, rare opportunities that are priced significantly below what we believe they are worth – these are the companies that offer an attractive potential return and decreased risk of loss.


Why does everybody not do this?

Those opportunities are so rare that our portfolio ends up being very focused and different from the market. Despite the long-term benefits of our approach to investing, being different means that performance will often diverge – and some of the divergences will be negative and persistent, not just short-term dips. The ultimate challenge of our contrarian approach is how we handle these periods.

Underperforming periods result because the market can simply move against our positions for some time, and because we can – and do – make mistakes. Clients are naturally concerned by these negative detours, especially because it is always unclear how long they might last. Doubts creep in and many investors feel the need to do something, often acting at just the wrong time.

Graph 1 shows the seven periods in our history where we have had significant drawdowns. While the relative performance line has agreeably sloped up over time, there have been more than a few periods of underperformance.

Although it may be deceptively easy to look at the blue line and say, ‘I can take this volatility’, in practice it is much harder to do nothing in the face of drawdowns. We cannot even help investors by telling them that because there has been underperformance, ‘outperformance is due’. Any period of underperformance can be followed by a short respite and another period of underperformance. Even though our approach seems sensible and rewarding in the long term, not everybody invests like this because periods of underperformance are of a very uncertain duration and hurt too much if one is not prepared to accept them.

Orbis Global's cumulative gross relative performance

So, what should you do?

Graph 2 looks complicated, but the gist of it is patience. The graph shows the range of the best and worst annualised gross relative performance experience over any holding period longer than one year throughout the Global Fund’s history. The Fund has outperformed the market by about 8% annualised since inception, but each client’s experience depends on when they invested and for how long they stayed invested. After investing in the Fund for just one year, the best possible outperformance was greater than 70% and the worst was underperformance of more than 10%. At the three-year mark, the range is still remarkably wide. It is only at the five-year mark that the range narrows and turns positive, even for the poorest period.

Historical range of gross relative performance

If a client was in the fat part of the cone on the left of the chart, having invested with us for any given one-year period, they may have been very happy with us – or really angry. But neither extreme reflects our true long-term performance pattern. The longer the holding period, the greater the likelihood that the client would have experienced the thin part of the chart towards the right – and that is what we aim for. (Note that the graph is based on Orbis’ historical data and is not a prediction in any way).

In the same way that we cannot time the stock market, we think it is equally futile to attempt to time our relative performance. Clients should expect our performance to be variable in the short and medium term, while stabilising only over longer holding periods.

We do not claim any grand insight into the big questions facing the world. What we do claim is that we will work hard to find stocks that look compelling, analyse them in the context of our consistent philosophy, reject most of them, and build a concentrated portfolio of our best ideas – those shares that we believe will reduce your risk of loss while increasing the chance that you will do well over the long term. Combine that with patience, and you may have a winning formula. 

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