Russia's lessons: Being a contrarian without getting burnt
Drawing from the experience of the Russian market's recent collapse, here are lessons one can take away on value investing and how one can be a contrarian investor and save themselves from being burnt.
In July, Dave Iben, a value-focused fund manager in the US who runs a mutual fund that invests across the globe, watched as pro-Russian separatists brought down MH17, flying over Ukraine.
Iben, whose Kopernik Global All-Cap fund was already overweight Russian equities compared to the MSCI benchmark it tracks, sensed now was a good time to add to his positions, as the Russian market tanked amid heightening geopolitical tensions.
Terming it “maybe the most extreme move ever” in his 33 years of value investing, in an interview with Bloomberg, Iben ran elaborate value tests – the Russian market was trading at 6 times earnings, compared to more than 10 times for China for 16 times for India.
A few months into the bet, oil prices sank, taking with them the Russian rouble -- the fortunes of resource-rich Russia economy, already facing sanctions from the West, are closely linked to crude prices.
The Russian currency is now down more than 50 percent versus the US dollar from its recent peak, and has resulted in a similar loss for the dollar-denominated Russian stock index.
In order to save the rouble, the central bank jacked up rates sharply but that should almost certainly tip the economy into recession. The word ‘default’ is also being used.
Iben’s fund, which has about 17 percent in Russian stocks, is down 27 percent in the past three months – the most in its category, according to Morningstar data.
Drawing from Iben’s experience, here then are lessons one can take away on value investing and how one can be a contrarian investor and save themselves from being burnt.
Beware of Black Swans: Hedge and diversify
Nassim Taleb describes a Black Swan as one “that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight”.
Taleb’s point is that black swans exist everywhere and are about impossible to predict. Black swans can even strike twice in fairly quick succession (contrary to what statistical models will have you believe), as Iben discovered in the form of the Ukrainian plane strike and the collapse in oil prices.
The key to protecting yourself from Black Swans is to diversify appropriately. One could do this by investing in so-called “negatively correlated assets”. The US dollar, expectedly, has risen as oil has fallen.
Another way to do this is to hedge specific risks.
For instance, Iben was investing in Russian stocks based on their cheap valuations and wasn’t taking a broad macroeconomic call. Thus, hedging the portfolio with the US dollar’s movement would have negated the currency risk, while allowing him to maintain Russian exposure. Case in point: the rouble-dominated MICEX index is almost flat for the year. It is the dollar-denominated RTSI index, which has plummeted.
You can’t time the bottom: What’s cheap can get cheaper
Iben’s call on Gazprom was mind-bogglingly simple: “Right now the market says we can have Gazprom at 2.5 times earnings, so we say ‘done’.”
It made sense to buy the world’s largest natural gas company, with its USD 150 billion in revenue and USD 35 billion in profit, at 2.5 times its earnings when, say by comparison, India’s ONGC trades at 13 times. The only problem is: the stock has continued to fall since Iben bought it and now trades at 1.8 times.
To hear it from one of the greatest contrarian investors ever, Jim Rogers, it’s virtually impossible to time the market when it’s a rapid downswing.
“Markets go up too far, and they go down too far. Once you start building the momentum, panic develops. People get more and more scared. Marching calls go out,” Rogers, who himself is invested in Russia, told the Wall Street Daily.
The key to surviving in such an environment is again not making bets you cannot afford to lose.
As Keynes said, the market can remain irrational longer than you can remain solvent: a mutual fund manager whose performance is tracked every month or a leveraged hedge fund manager, who could get a margin call from the broker, can hardly ride out such wild swings.
Fortunately, the task becomes simpler for an individual investor. All she has to do to, after the downturn, go back and check if the original thesis that prompted the investment is still valid even in a seemingly changed environment. If it is, hold on but beware of behavior biases such as anchoring that may keep you from selling it even if you have discovered you were wrong.