Part of Netwealth's portfolio construction webinar series - Chris Inifer from Allan Gray presented to an audience on 12th July 2016 on how a contrarian investment approach may help protect against poor human decision making that are often driven by emotion and biases.

1. Why do people make irrational
investment decisions?
How to make sure you don't.
Netwealth portfolio construction webinar series
July 12, 2016

2. Disclaimer
This Technical Review has been prepared and issued by netwealth Investments Limited (netwealth),
ABN 85 090 569 109, AFSL 230975, ARSN 604 930 252. It contains factual information and may also
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4. Meet today’s
speaker
Chris Inifer
Head of Retail
Allan Gray

5. 5
IT’S DIFFICULT BEING DIFFERENT
JULY 2016

6. 6
• Who is Allan Gray
• The human – one smart primate
• The investor’s chief problem
• How this behaviour appears in financial markets
• A practical solution
• Current market thoughts – where to invest?
AGENDA

7. 7
10 years of
investing in
Australia
Established in
South Africa in
1973
Allan Gray
Australia began
operating in
Sydney and
applied for a AFSL
Allan Gray Australia
received their licence
and launched the
Allan Gray Australia
Equity Fund
Allan Gray
Australia launched
the Allan Gray
Australia
Opportunity Fund
The Orbis Group is
formed in Bermuda
1973 1989 2005 20112006 2016

8. 8
THE HUMAN BEING – ONE SMART PRIMATE
Source: Wikipedia and The Age, August 2010

9. 9
The investor’s chief problem

10. 10
THE INVESTOR’S CHIEF PROBLEM
Source: Dalbar study 1990 to 2010, Behavior Gap Carl Richards
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
S&P 500 Average equity investor
20 year annualised returns

11. 11
WHY ARE WE THIS WAY? – SOCIAL PROOF

12. 12
WHY ARE WE THIS WAY? - AUTHORITY

13. 13
ARE YOU MCCOY OR SPOCK?
X System (McCoy)
• Similarity
• Familiarity
• Proximity
Source: The X and C Systems, Matthew Lieberman, 2007
C System (Spock)
• More logical
• One step at a time

14. 14
COGNITIVE REFLECTION TEST
1. A bat and a ball cost $1.10 in total. The bat cost $1 more than the ball. How much
does the ball cost?
2. If it takes five minutes for five machines to make five widgets, how long would it take
100 machines to make 100 widgets?
3. In a lake there is a patch of lily pads. Every day the patch doubles in size. If it takes
48 days for the patch to cover the entire lake, how long will it take to cover half the
lake?
Source: S.Frederick, ‘Cognitive Reflection and Decision Making’, Journal of Economic Perspectives 19 (2005): 24-42
McCoy Spock
1. 10 Cents 5 cents
2. 100 Minutes 5 Minutes
3. 24 Days 47 Days

15. 15
THIS ONE IS FOR SPOCK
17 x 24
23 x 44

16. 16
• When the problem is ill structured or complicated
• When information is incomplete, ambiguous and changing
• When goals are not defined or change or compete with each other
• When stress is high because of time or other pressures
• When decisions rely on interactions with others
WHEN ARE WE MOST LIKELY TO USE X SYSTEM?
These typically apply to investment decisions…
Source: See Gary Klein: Sources of Power: How People Makes Decisions (Cambridge, MA: MIT Press, 1999)

17. 17
How this behaviour appears in financial
markets

18. 18
• Overconfidence
• Loss aversion
• Recency bias
• Confirmation bias
• Self interest
INVESTORS’ BEHAVIOURAL BIASES

19. 19
• Illusion of control
• Consider too small a range of outcomes
• We recognise mistakes in others more readily than in
ourselves
• The ‘experts’ are often more overconfident
OVERCONFIDENCE

20. 20
MACRO FORECASTS AND OVERCONFIDENCE
“Stock prices have
reached what looks like a
permanently high
plateau”
“Dow 36,000”
“Dow 40,000”
“Dow 100,000”
Dow Jones Industrial Index 1929 – 1955 Dow Jones Industrial Index 1996 – 2012
Source: Bloomberg, Professor Irving Fisher, Economist, October 1929. Quotes, J.Glassman, K.Hassett and C.Kadlec

21. 21
WHERE WOULD YOU INVEST?
Country Real GDP per capita growth
A 3.8
B 2.6
C 2.6
D 2.5
E 2.4
F 2.2
G 2.2
H 2.2
I 2.1
J 2.1
K 2.0
L 1.9
M 1.8
N 1.6
O 1.5
P 1.2

22. 22
IS GDP GROWTH GOOD FOR SHAREMARKETS?
0
1
2
3
4
5
6
7
8
Ita Bel Ger Fra Spa Ire Jap Nor Swi Den Net Fin UK Can NZ US Swe Saf Aus
Real equity return Real GDP per capita growth
Source: Dimons, Marsh & Staunton, ‘Triumph of the Optimists’, Princetown University Press, 2002
Real Equity Returns 1900 – 2000

23. 23
LOSS AVERSION
• We feel pain of loss greater than pleasure of win
• Leads to temporary paralysis and irrational behaviour
A real life study
• You are given $20 to play a game with 20 rounds
• At the start of each round choose whether to invest
• Each round a fair coin is flipped
• If heads you win $2.50. If tails you lose your $1.
‘Normal’ group ‘Fearless’ group
Overall participation: 58% 85%
After losing rounds: 40% 85%
Source:B. Shiv, G. Loewenstein, A. Bechara, H. Damasio, and A. Damasio, ‘Investment Behavior and the Negative Side of Emotion’, Psychological Science 16 (2005)
The result may surprise you…

24. 24
RECENCY BIAS
70
80
90
100
110
120
130
140
150
160
170
180
190
200
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
InvestmentGrowth
S&P/ASX 300 TR S&P/ASX Australian Fixed Interest TR AUD
• We tend to overweight the
recent past in expectations of
the future
• This leads us to buy and sell at
the wrong time
• There are 11 ASX listed fixed
income ETFs. All launched in
2012
Source: Morningstar

25. 25
RECENCY BIAS
+7.6% p.a.
-3.7% p.a.
+5.8% p.a.
Returns on Australian Bonds and Cash, 1900 – 2000, after inflation
Leads to buying
and selling at the
wrong time
Source: Dimons, Marsh & Staunton, ‘Triumph of the Optimists’, Princetown University Press, 2002

26. 26
CONFIRMATION BIAS
• We are more receptive to information that confirms our existing beliefs
• Less receptive to information that contradicts our existing beliefs
• We don’t like to change our minds
• It’s easier that way
• It allows us not to think

27. 27
CONFIRMATION BIAS
Time
Intrinsic Value
Share Price
Value
Company A
• In a booming industry
• ‘BUY’ recommendations from
many stock brokers
• Positive media coverage
• Friends have made profit and
are buying more
Company B
• Industry facing cyclical downturn
• ‘SELL’ recommendations from many stock
brokers
• Negative media coverage
• Friends lament losses and are selling out

28. 28
SELF INTEREST (CAREER RISK)
If you were a fund manager, would you prefer….
a. 80% chance of double bonus and 20% chance of getting fired
b. Guaranteed average bonus
Leads fundamental managers to make non-fundamental decisions (e.g. ‘this
company is 10% of index – having zero exposure is too risky’)

29. 29
LEADS FUNDAMENTAL MANAGERS TO MAKE NON-FUNDAMENTAL
DECISIONS
Source: Morningstar as at April 2016
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
CBA WBC NAB ANZ TLS BHP WOW WES CSL SUN
Weight(%)
Weight of share in SPDR S&P/ASX 200 Fund
Average weight of share - 5 largest active managers (Morningstar 'Australian Equity Blend' category)
Weight of share in Allan Gray Australia Equity Fund

30. 30
Practical Solutions

31. 31
Shut out noise
• Our McCoy System loves a good
story – don’t feed it!
• The media is paid to fill pages and is
best ignored
• ‘Leading experts & economists’ are
also paid to supply a good story
• Don’t believe them!
• Use your C System and independent
thinking instead

32. 32
BE CONTRARIAN
‘Broker slashes its BHP
profit forecast 12pc’
Sydney Morning Herald
April 4, 1998
‘Fairfax shares fall as
losses hit $2.7b’
The Age
August 23, 2012
Reasons to
sell?
‘BHP makes $58m
profit per day’
Sydney Morning
Herald
February 16, 2011
‘Earnings at record
level’
Fairfax Media Annual
Report, 2000
Reasons to
buy?

33. 33
BE CONTRARIAN
‘Broker slashes its BHP profit
forecast 12pc’
Sydney Morning Herald
April 4, 1998
‘BHP makes record profit’
Sydney Morning Herald
February 16, 2011
‘Earnings at record level’
Fairfax Media Annual Report, 2000
‘Fairfax shares fall as losses
hit $2.7b’
The Age August 23, 2012
Source: Allan Gray data base to 2013

34. 34
DISTINGUISH VALUE FROM PRICE
Value
• What you get
• Stable
• Driven by
fundamentals
Price
• What you pay
• Volatile
• Driven (in short
term) by ‘animal
spirits’
Value – Price = Excess Return

35. 35
SEEK ALIGNMENT OF INTEREST
Strategy 1 Strategy 2 Strategy 3
Division A Fund Mgt Division
Fund Manager
(Individual)
Financial Services Firm
Fund Manager
(Individual)
Alignment stronger
Alignment weaker

36. 36
Social proof
“Expert”
opinion
Your
existing
opinions Be VERY careful !

37. 37
Allan Gray – Current Thoughts

38. 38
ASX 300 INDEX FUNDAMENTALS
Source: Allan Gray Data base as at June 2016
500
1000
1500
2000
3000
5000
10000
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
ASX 300 Index
10 x Earnings
10 x Dividend
Book Value

39. 39
A DIFFICULT TIME FOR VALUE INVESTORS
-10%
-5%
0%
5%
10%
15%
20%
25%
1995 2000 2005 2010 2015
Rankcorrelationofstocks
Source: MSCI data, Deutsche Bank, Allan Gray analysis as at January 2016

40. 40
Newcrest Mining 11.1%
Woodside Petroleum 8.6%
Origin Energy 7.9%
Alumina 7.8%
Metcash 5.7%
3.8%
3.2%
APN News & Media
3.3%
National Australia bank
2.7%
Southern Cross Media Group
2.4%
TOP 10 HOLDINGS AS AT 30 JUNE 2016
Company % of Allan Gray Australia Equity Fund
AusNet Services
Worley Parsons

41. 41
• Don’t listen to ‘the experts’
• Recognise biases and be contrarian
• Distinguish between Price and Value
• Demand alignment of interest
• Evaluate your own decision making honestly
• Value is available
……Just because it’s popular doesn’t mean it will make money!
SUMMARY

42. 42
About this presentation and the Allan Gray Australia Equity Fund and/or
Allan Gray Australia Opportunity Fund (together Funds)
Objective of presentation To provide you with some key high level information about our investment philosophy and the Funds.
Please don’t take this presentation as an offer to sell or a recommendation that you should invest in the Fund. Please read the
Fund’s most recent Product Disclosure Statement and Information Booklet (together PDS) before deciding to invest in the Fund. A
free copy is available from www.allangray.com.au/documents/ProductDisclosureStatementAGEF.pdf
www.allangray.com.au/documents/ProductDisclosureStatementAGOF.pdf
Issuer of units in the Funds Equity Trustees Limited, AFSL No. 240975
Investment Manager Allan Gray Australia Pty Ltd, AFSL No. 298487
Fund registration The Funds are managed investment schemes registered with the Australian Securities and Investments Commission. The Funds
are also registered for promotion in South Africa and New Zealand.
Who can invest? The Funds are aimed at investors in Australia. The Funds do not accept US persons and are not marketed in the European
Economic Area (EEA). Investors resident in the EEA can only invest in the Funds under certain circumstances and determined by,
and in compliance with, applicable law.
No personal advice This presentation has been prepared for financial advisers and only provides general information. All information provided does not
take into account any investors personal financial circumstances, objectives or needs. You should read Allan Gray Australia’s
Financial Services Guide, which sets out the benefits we or our related entities are entitled to receive (such as fees payable to us
as investment manager). The FSG is available on our website.
Investments can go up and down There are risks with any investment, including one in the Funds. Please read the risk section of the PDS for more details. Past
performance is not a reliable indicator of future performance and the value of any investment in the Funds is not guaranteed.
Economic, market or stock commentary Such information is provided to indicate reasons for our investment decisions or represents our views on certain matters. It is not
intended to be personal financial advice. Such commentary is not a recommendation to deal in any security or instrument.
Other Finally, please seek professional advice, if necessary. We have tried to ensure the information in this presentation is accurate in all
material respects but cannot provide any guarantee that it is.

43. Questions & Answers