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Introducing Our Thinking

By Orbis Investment Team
June 2015
5 mins. To Read

With our reporting, we aim to put you in the best possible position to make informed decisions about your investments. With our commentaries, we hope to improve your understanding of our fundamental, long-term, and contrarian investment approach, and we continually work to improve the content we provide to you.

Our Thinking will cover a range of topics, from investment views on companies and the opportunity set to our take on enduring investment issues. In quarter end months, we expect that the quarterly commentaries will continue to be our preferred communication channel. We are hopeful that this flexibility will help us better assist you in evaluating Orbis and our Funds.

Why bother with active management?

2014 was one of the worst years on record for active management, and it has become fashionable to talk about how difficult the past several years have been for active managers. While we believe there is some evidence to support this view, it is misleading in a sense, because it is always difficult for active managers to outperform. To understand why, we need to step back and view the investment universe as a whole.

Active managers (and some individual investors) aim to beat the market’s return by holding a different collection of investments, and passive managers aim to deliver the market’s return by replicating it. If we treat the investments of every active, passive, and individual investor as one big portfolio, that portfolio will be the market as a whole, and the return on that portfolio will be the market’s return. This makes active investing a zero-sum game—the total amount “won” by those who beat the market must equal the amount “lost” by those who lag.

Importantly, active management is a zero-sum game before fees, so after fees, active investors’ average return will be worse than the market’s return to the tune of the average fee. Proponents of index investing point to this as a reason to favour passive investments. Because index funds approximate the market’s return and typically have lower fees than active funds, passive investors’ average return will typically be higher than that of active investors.

So why bother with active management? We believe there are two main reasons. First, active strategies offer the potential for superior long-term returns. Over our 25-year history, we are pleased to have delivered better returns for our clients than what they could have earned through comparable passive strategies. Performance comprises both returns and risk, and we believe the second main benefit of active management is the potential for reduced risk. Unlike index funds, the Orbis Funds routinely go through periods of substantial underperformance, and as clients ourselves, we appreciate that these periods can be painful. But we believe the biggest risk our clients face is not the risk of underperformance, but that of a permanent loss of capital. In our view, the best way to reduce this risk is to limit the magnitude and length of drawdowns in the absolute value of the Funds. We are pleased that the Funds have generally experienced smaller drawdowns and faster recoveries than their benchmarks over our history.

Yet even if active management generally has merits, clients must still try to identify managers who can win the zero sum game. What makes us think we can be one of the winners?

As the popular disclaimer says, past performance does not guarantee future results. Active managers aim to produce different results than the market, but particularly over short periods, a manager’s results alone tell you little about their level of skill. To assess skill, we believe it’s necessary to look past the headline numbers and examine the decisions that generated those numbers.

A good starting point here is the manager’s portfolio—it’s hard to beat the market by hugging it. The active share measure captures the extent to which a portfolio overlaps with its benchmark. An active share of 100% means the portfolio has no overlap with the benchmark; 0% means the portfolio has no difference. All of our equity strategies have consistently had active shares of above 80%, indicating highly active portfolios.

Of course, being different from the benchmark creates the potential for underperformance as well as outperformance, and this can make it difficult to maintain a highly active approach through market cycles. We believe the best opportunities arise when investors become fearful and pessimistic, driving security prices to less than they are worth. Faced with turbulent situations, even skilled investors can disagree on the best course of action, and if faced with a need to achieve consensus, it may be difficult to take any action at all.

Being contrarian requires being out of sync with conventional thinking—and being painfully wrong at times. Recognising this, at Orbis all investment decisions are made by individuals. These independent decisions then form the core of our stockpickers’ evaluations. By emphasising individual accountability rather than consensus decision-making, we believe we stand a better chance of capitalising on attractive opportunities.

Even if we are able to find attractive opportunities, delivering good long-term returns on your behalf is still challenging. All managers have an incentive to increase their assets under management, which can come at the expense of performance for existing clients. We try to temper this impulse by aligning our financial incentives with our clients’ interests. All of our fees are performance-based, and we invest alongside our clients on identical terms.

Taken together, we believe our alignment of interests, individual accountability, and benchmark independence give us a reasonable chance of being one of the winners in the zero sum game. But words aside, the proof of the pudding is in the eating. The only thing we can guarantee is that we will continue to work hard to produce pleasing long-term results.

This Report does not constitute advice nor a recommendation to buy, sell or hold, nor an offer to sell or a solicitation to buy interests or shares in the Orbis Funds or other securities in the companies mentioned in it (“relevant securities”). It has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Orbis, its affiliates, directors and employees (together, the “Orbis Group”) are not subject to restrictions on dealing in relevant securities ahead of the dissemination of this Report. Subscriptions are only valid if made on the basis of the current Prospectus of an Orbis Fund.

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