I have two children, a daughter, Sydney-Bo who will be five on her next birthday, and a baby boy, Saxon, who recently turned one. I consider fatherhood to be the most rewarding investment I have ever made, not only for the pleasure that it brings, but also the challenges it sets and the lessons it has taught me.

A little while back I was chatting with my daughter one evening when she raised the topic of my career in asset management. “What do you do at work, daddy?” she asked. Explaining asset management to a four year old is no average task, so I thought that it would be sensible to stick to the basics. “My darling, I make money for people,” I told her. Whilst only four, her eyes immediately went wide as she recognised the promise of this statement: money buys Baby Annabelles. However, my daughter is no fool, and her regular visits to my office have never revealed a money-making machine to her, which she noted as our discussion become more serious. So her interrogation proceeded: “How do you make money daddy?”

“I need just two ingredients my angel,” I explained. “I need an investment philosophy founded in the principles of value investing, and I need time. If you give me these two ingredients I will make you money.”

Sadly, most investment managers fail – or at least struggle – to capture either of these ingredients. A value philosophy involves adopting some tough stances that often are at odds with common sentiment; and patience is a scarce commodity. The current South African environment provides ready examples. The massive infrastructural spending pipeline that is in place, and that is set to continue flowing over the next few years, is producing rapid earnings growth in building and construction stocks. The hype around this theme has seen stocks in the sector rerate significantly over the past few years and, in turn, the positive sentiment has encouraged a raft of new listings associated with building and construction that capitalise on the mood of the market.

As evidence of this, the price-earnings ratio for the sector currently sits at twice its historical average, and more than half of the new listings this year are building and construction-related businesses. But no matter how glamorous the outlook, a price-earnings ratio of around 25 times trailing earnings and a dividend yield of less than one percent is expensive relative to a market trading on an earnings multiple of just over 15 times and a dividend yield of 2.3 percent. Yet popular sentiment amongst market participants is that these are “must own” stocks.

This is not the consequence of sound investment management, but rather the product of herd-like behaviour. Crowd sentiment results in portfolios holding lots of expensive building and construction stocks – because they are popular, not because they are great investments.

Herding happens because for professional investment managers it is safer for your career to be wrong with a crowd. As Philip Fisher (1960, 41) put it in Paths to Wealth through Common Stocks: “It is all right to lose heavily, as long as you do it in good company.” Standing apart from the crowd is the only way in which a manager can produce investment results that are better than the market. But a contrarian stance that is at odds with the herd means that if you are wrong, you are wrong on your own. For this reason, whilst it can be easily demonstrated that the only way to beat the market is by being different to the market, adopting a contrarian or value stance is a hard position to assume.

As for patience, as already noted, this is a scarce resource. Although evidence shows that the best investment results are those generated by far-sighted investment processes that have low portfolio turnover, it is human to be impatient and seek immediate gratification. It is also human to want to be seen to be doing something – like turning a portfolio over. The absence of patience in the local setting is evidenced by the fact that the average unit trust in South Africa is turned over once a year.

Thus, few managers are able to harness these two most critical ingredients for successful investment results: a contrarian value stance and the patience to see the decision through to an investment result. But, if you are able to tie these two ingredients together, then you have a platform for success as an investment manager. Of course, I could simply have told Sydney-Bo that I have an invisible alpha-extracting machine at the office that makes money – but then she is only four and still believes in Father Christmas. One day her parents will have to tell her that Father Christmas doesn’t exist, just as I will have to tell her that for three-quarters of investment managers alpha extraction is a fantasy.

Both Sydney-Bo and Saxon hold investments in the Cannon Equity Fund and Cannon Core Companies Fund.

End Note: A Contrarian View

Readers may be interested to know that the portfolios I look after step a long way away from the herd. By way of example, the Cannon Equity Fund and Cannon Core Companies Fund have less than 40 percent overlap with their benchmarks. Our portfolios have not held any of the newly-listed building and construction stocks and have produced substantially better-than-market results for our investors. The patience of the investment process is evidenced by exceptionally low portfolio turnover: it took my investment team seven years to turn over the segregated Cannon All Equities portfolio once.