Dr Shane Oliver, the chief economist and Head of Investment Strategy at AMP Limited (ASX: AMP), has just released an interesting article titled: 'Why investors need to be wary of crowds'.
Before warning readers that it could be time for investors to start being wary of the crowd's recent negativity (timely advice given the subsequent rally in the past few days), Dr Oliver firstly reminds us of the potential dangers from being amongst the crowd and draws our attention to Warren Buffet's wonderful and famous line, "be fearful when others are greedy and greedy when others are fearful".
So why can it be dangerous to hang around in crowds?
As Dr Oliver puts it –
"The trouble with crowds from an investment perspective is sourced in investor psychology. It is well known that individuals suffer from lapses of logic. For example, they tend to down-play uncertainty and project the current state of the world into the future – e.g. resulting in a tendency to assume recent investment returns will continue".
One of the problems of standing with the crowd is an investor's judgement is likely to be swayed by the crowd's behaviour. This is particularly troublesome at points of maximum optimism and pessimism; at these points being part of the crowd's thinking will likely lead to buying and selling assets at exactly the wrong time.
For these reasons (and others) Dr Oliver recommends that, "while it may feel uncomfortable, successful investing requires going against the crowd – particularly when the crowd is at extremes of bullishness and bearishness".
Foolish takeaway
Being prepared to act against the investment crowd requires one to have a contrarian mindset. One of Australia's most respected contrarian fund managers is Allan Gray. As at the end of January, Allan Gray's flagship Australian Equity Fund's three largest positions were the troubled SP AusNet (ASX: SPN), the cheapest and least-liked bank National Australia Bank Ltd (ASX: NAB) and the deep value opportunity Alumina Limited (ASX: AWC). These contrarian positions are of course not popular with the crowd, however as the fund's outperformance proves – a contrarian approach to investing can work.
