The Road Not Taken: Contrarian Thinking is a Critical Part of the Royce Approach

"Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference."

— Robert Frost, "The Road Not Taken"

The techniques of contrarian investing are often cited as critical attributes for those investors striving to outperform both their peers and the indexes to which their results are often compared. Here at Royce, we wholeheartedly accept the contrarian designation, with certain caveats. The most obvious, and yet probably the most significant, one is to recognize that from time to time the consensus view will be correct.

Successful contrarian investing involves more than the willingness to swim against the tide, which we all know can be exhausting. Our approach focuses on consistently applying our time-tested investment discipline that, at its core, integrates an assessment of a company's absolute value with critical and independent thinking. This analysis often begins with a study of the consensus view of a company (or its industry) so that we can weigh the potential risks and benefits of acting differently.

Few would argue the merits of remaining in a burning theater when all the other moviegoers have rushed for the exit, or to ignore a group of swimmers who are all screaming, "Shark!" That said, even in these two admittedly extreme examples, thinking critically (and quickly) can improve the outcome. Perhaps one theater exit is safer and easier to reach than another. Maybe the purported shark is nothing more than a curious dolphin. In each scenario, recognizing the potential validity of the consensus view is important; however, thinking carefully about what to do with that information is what will ultimately determine success or failure.

When we describe our investment style, you will often hear us say that we are "agnostic" about a number of issues. Interestingly, the word "agnostic" shares some qualities with the word "contrarian" in that both imply an unwillingness to conform with what is expected or to commit to the conventional view.

For example, we are agnostic about investment styles, choosing to select securities from the entire universe of stocks, not just the value portion with which we are most often associated. We are agnostic about our funds' sector weightings, choosing instead to build portfolios consisting of the best absolute return ideas our managers can find, irrespective of how we might deviate from the sector weightings of a benchmark index. Our focus on high-quality businesses with compelling absolute valuations also frequently leads us to companies that are out of favor with Wall Street's consensus.

Turnover is another area where we deviate from conventional investment behavior in order to give ourselves the best opportunity for success. As has been well publicized, the average time horizon for investors has compressed markedly and is now counted in months. Many reasons can be cited for this behavioral change, yet what remains important for us is how companies behave as businesses. Having studied companies for close to 40 years, we know that very little about the business cycle has changed. We focus on the long term because in our collective experience that is what good companies do, and we prefer to align ourselves with good companies rather than with the ever-changing whims of investors. Patience is an increasingly rare commodity in equity investing, one that we believe has increasingly become a contrarian characteristic.

Warren Buffett once aptly summarized investing as a game of baseball with no called strikes. Picking the right investment opportunities requires discipline, patience and a skeptical eye on conventional wisdom. Over time, that is what makes all the difference.