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You Must Be Crazy!

December 28, 2006 by  


By Bob Wood

I hear those words from time to time when talking with investors about my favorite places to invest. If you don’t hear the same words occasionally when talking about your top holdings, you might be missing the best opportunities for profiting in the market.

In fact, I heard “You must be crazy” just yesterday after someone mentioned how smart it was to stay away from the market in Thailand and I admitted having investments there and thought they were a great idea. And when I said I had just bought into a closed-end fund dedicated to Thai shares, I again heard the ‘’crazy’’ term.

Yeah, okay, maybe it does sound a little nutty to invest where a recent coup ousted the nation’s leader. And the new government recently announced currency controls that helped generate enough investor fear to cause the stock market to fall 16% in one day. But that event was enough to spur the government to remove the controls the same day.

When asked why I would consider investing in such a risky market with all the other alternatives available, I recalled other markets that looked equally risky and frightened off the crowds who felt safer investing closer to home. How many U.S. investors preferred buying domestic technology stocks in 1998 or 1999 when valuations could only be explained by promoters who made up reasons as they went along, such as how traditional valuation metrics were simply outdated?

Instead, investors could have chosen Russian equities. Yet at that time, they would have been labeled “crazy” to invest in a market where a weak government had recently defaulted on debt payments, marking that country as one of the riskiest places to invest. In 1998, the Russian stock market sat at about the 100 level. Today it is over 1,800. And those U.S. technology shares, as shown by the tech-heavy Nasdaq index, are lower now than in 1998 and much lower than 1999 levels. So who looks crazy now?

How many investors thought seriously about opportunities available in Brazil’s stock market in 2002, when U.S. investors were still smarting from damage caused by the bear market cycle which began in early 2000? Those who did certainly were viewed as crazy, investing in a third-world country with a spotty record in economic performance and, of all things, a Socialistic new leader, Lula da Silva. Only real nuts would invest in a socialistic economy, right?

When the S&P 500 was hitting bottom at about 850 in late 2002, as it began its current four-year rally up to about 1,425, Brazil’s Bovespa index was hitting bottom at about 8,800. The Bovespa index is now at an all-time high of over 43,000, while the average annual return for the S&P 500 during the past four years has been about 14%. In comparison, the crazy investors who bought Brazilian shares then have earned almost 50% yearly.

And who would have guessed a year ago that one of the hottest, most profitable markets in the world would be in Venezuela? Who in his right mind would invest in a country’s stock market when its leader is an avowed Socialist revolutionary? And haven’t we all heard how badly socialistic tendencies affect free market capitalism? Of course, in my no-so-humble opinion, I think we tend to hear that from people who value profits over people.

The crazies who put money into Venezuelan shares last year have gained about 140% this year as measured by that market index. And the Peruvian market has achieved similar gains this year.

Investors who allocate funds into gold shares have long been considered “mentally deficient”; they are often called ‘’Goldbugs,’’ if not worse. Some say only ‘’the gloom and doomers’’ think gold is a viable asset class. After all, gold does not generate profits or pay dividends, so why bother? And didn’t gold investors endure a very long bear market, which lasted almost 20 years, while stock market investors were making bundles of money? So investing in gold in the late 1990s was called nutty, too, and many still think the practice is rather crazy. But take a moment to build a chart on Yahoo Finance or bigcharts.com. Compare your favorite gold mutual fund with the S&P 500 for the past five years. Now how crazy does gold look to you?

Yes, having investments in gold looks perfectly sane now. But a few years ago, it seemed mighty weird to be allocating money to gold when promoters were projecting that the Dow was headed to 36,000. And, yes, the Dow investor’s thinking then looks crazy now, since we know the crowd bought into it at the worst time!

Not only foreign markets or asset classes like gold make the best, if not more unlikely, places to profit in the markets. Investors can also find individual stocks that rarely appear on radar screens of fund managers and other large investors. Some of my most profitable stock selections over the past three or four years have been those that few have heard mentioned. And they are never touted on CNBC.

Most investors looking to buy into the energy sector have been much more likely to look at familiar names such as ExxonMobil or Chevron. Meanwhile, shares of one of my favorites, Brazil’s Petrobras, have strongly outperformed those better-known domestic stocks. I like to call stocks like that one ‘stupid stocks’, since people, when hearing me talk of them typically ask something like, ‘’what are you, stupid’’?

Shares of domestic auto makers such as General Motors or Ford trade in far greater numbers each day than shares of the lesser appreciated Honda Motor. Look now at a performance chart using those three names over the past five years. And while U.S. investors have bought and sold hundreds of millions of shares of well know Citigroup, my clients have done far better with shares in India’s ICICI Bank or HDB Bank and Brazil’s Unibanco.

To me, “crazy” happens when investors keep almost $50 billion tied up in the Fidelity Magellan fund, which has been a tepid performer, at best, over the past five years. Many lesser known options have done far better. What are investors in that well known fund thinking? The returns generated by the Magellan Fund are well below those of lesser known funds, such as those managed by an advertiser on this page. But you’d have to be crazy to invest in much smaller funds with restricted mandates, right?

Actually, I always look for smaller funds and, in many cases, the less-well-known closed-end funds for investment opportunities, especially in foreign markets. While few investors bother to seek out better options than the large funds from the largest fund families, smaller funds often benefit from the ability to invest in more concentrated portfolios, allocating money only to their best ideas. Larger funds become index trackers, and who needs to pay extra for that with low-cost index funds widely available?

Some may think it is crazy to invest in lesser known stocks, mutual funds or less-appreciated markets like Russia, Brazil or Thailand. But I think what the crowd sees as totally sane and widely accepted has already been stripped of its profit potential. And just because the crowd is unaware of the unfamiliar names doesn’t mean they are not good investments.

For me, going where the crowd will not go is a good thing. And looking for the undiscovered gem lies at the heart of what has worked well for investors over the long run. Few long-term success stories are told by those whose financial security was generated by the stock market.

My three favorite stocks right now are Industrias Bachoco (IBA), KHD Humboldt Wedag (KHDH) and Grupo Casa Saba (SAB). While some think I must be losing my grip after hearing that I am heavily invested in these names, I think they’re crazy for staying with those tired winners of past years – those that dominate the daily list of most actively traded stocks.

As former fund manager Ralph Wanger teaches, it is the zebra who lingers at the edge of the herd that eats the best and has a better view of approaching threats. I believe the investor who looks to the far reaches of the markets and does some diligent research before buying will see the best performance, too. It might look crazy to some, but to me, it’s the sanest approach there is.

Have a great week,
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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