The difference between contrarianism and stubbornness

One of the hardest lessons for me to learn as an investor was when to divorce an investment. I started my career at UBS when it was still dominated by the value investment approach of Gary Brinson. Value investing also suits my personality because, honestly, I like being contrarian and am overconfident enough to think that I am right when the “masses” are wrong. And value investing requires a certain dose of contrarianism. After all, you have to identify investments that are undervalued, often because they are shunned by the public or because they are in some deep doo-doo. And once you have identified these investments, you must hold on to them, often for years, before they appreciate towards their intrinsic value. Thus, value investing requires stamina and a certain amount of conviction to hold on to investment in good times and bad.

But not until death does us apart…

The mistake I made too often in my career was to hold on to a value investment for too long. In a sense, I was marrying my investments and got emotionally too attached to them. This emotional attachment blinds your view to news, data or simply market developments that contradict your original investment thesis. The danger in these situations is that you start to completely discount this information or that you hold on to your investments as they lose value in the hope that the eventual recovery – when it arrives – will allow you recoup these losses and more. But contrarianism is distinct from stubbornness. And by the point an investment had gone down by a lot, I often had become too stubborn to admit defeat and critically question my investment thesis.

Thus, in my view, one of the most important character traits for value and contrarian investors is to be able to cut losses when an investment fails. This is much harder for them than it is for traders, for example. Traders learn very quickly that they should not get attached to their investments but cut losses and move on. If they don’t do that, they will end their career very quickly. Nick Leeson of Barings Bank is one great example of a trader who got invested in his investment thesis too much and then went rogue as he refused to admit defeat and cut his losses.

Unfortunately, learning to divorce your investments before they sink your portfolio is not something that is easy. The literature on cognitive dissonance tells us that it is in our nature to seek out information that confirms our beliefs and ignore or discount information that contradicts it. The all-time great value investors are able to cut themselves loose from an investment that does not turn around in time, without much regret, but we mere mortals probably have to use specific techniques to prevent us from getting stuck with a losing investment.

The two techniques that have worked best for me are to define stop losses and use moving averages as triggers to reduce or sell a position. Today, when I invest in a stock or another asset, I tend to place a stop loss that is roughly one standard deviation below the current market price. If the stop loss limit is hit, then half or all of the investment will be sold automatically. Similarly, I may sell half or all of my position if the share price drops below some long-term moving average like the 200-day or 400-day moving average. These mechanical rules are by the way a result of a painful learning process, because in the past, I would not automatically reduce positions if a certain trigger was hit. Instead, I chose to set these triggers and then only “review” my investment thesis. But as you might guess, by that time I was emotionally so invested that I chose to override the stop loss for whatever reason came to mind. The review of my investment diary showed me the disastrous results these decisions had in my portfolio all too clearly.

Thus, no matter how contrarian of value-oriented an investor you are, it pays to define the circumstances that force you to sell an investment right at the start of an investment – and then implement them mechanically without the possibility to override these decisions in the heat of the moment. Unless you are a value investment legend, this is likely to help you deal with your emotions and your impulse to remain stubbornly invested in an investment even though there may never be a reasonable chance to recover the losses incurred in the past. Always remember that being contrarian for too long is indistinguishable from being stubborn.