Behavioural approaches: Different types

CONTRARIAN

Contrarian investing is, as the name suggests, doing the opposite to what most would consider the norm. Selecting and investing in out of favour stocks, sectors or themes which are therefore at a lower price and then selling out once they start to perform well and come back into favour. One of the aims of this approach is to try and avoid investor herding by actively choosing to invest in unloved areas, but based on fundamental analysis rather than just going against the crowd for the sake of it.

VALUE

Value investing is at its core about buying good companies at a price less than their fundamental value, effectively bargain-hunting. Investors adopting this approach believe markets overreact to news, both good and bad, and so stock prices do not always reflect the underlying quality of a company. As with most behavioural strategies, the investment bias is then supported by fundamental analysis, with the so-called godfather of value investing – Benjamin Graham – creating with David Dodd the Graham & Dodd price-to-earnings ratio that remains a useful tool for value investors.

MOMENTUM

There are few investors that might willingly admit to being momentum investors, where they look to capitalise on existing trends in the market by investing in ‘hot’ stocks that are on the rise and selling those that are starting to fall. The obvious flaw in this strategy is one of timing, where the investor has to be sure the ‘hot’ stocks aren’t already at their peak and not waiting too long to sell the falling holdings. However, the idea that themes and trends tend to continue one way for a reasonable amount of time rather than suddenly going against the flow is plausible. Research from Professor Joseph Lakonishok suggests that buying high momentum stocks – measured by their previous six-month gains – outperform low momentum stocks by 8-9 per cent the following year. Although it comes with the caveat that the underlying company still needs to have good fundamentals.

BEHAVIOURAL FINANCE: MAIN PLAYERS

CONTRARIAN INVESTORS:

Neil Woodford, Invesco Perpetual:

The equity income manager has made a number of clearly contrarian calls on themes in his time, most notably in the 1990s when he invested heavily in tobacco at a time when the industry appeared to be struggling. He shunned technology in the TMT boom and avoided banks in the run-up to the crisis.

Alastair Mundy, Investec Asset Management:

Mr Mundy has been head of the contrarian investing team at Investec since 2002, and in 2012 published his first book on contrarian investing. In an interview with Investment Adviser in 2011 he explained: “I’ve always said that in your DNA there are two types of investor; one who likes buying stocks as they go up, that’s a momentum investor, and there’s one group of investors that like buying stocks as they go down, and that’s a contrarian. I just happened to be the contrarian.”

VALUE INVESTORS:

Nick Kirrage and Kevin Murphy, Schroders Investment Management:

Schroders’ Nick Kirrage and Kevin Murphy are traditional ‘value’ investors. Managers of the Schroder Recovery fund, and the newly launched Schroder Global Recovery fund – on which they are joined by Andrew Lyddon – they focus on exploiting the swings in stockmarket sentiment. This means that they target those companies that have been given a market valuation which is significantly less than what the managers believe to be the ‘true worth’ and are likely to experience a correction.