Value investing has historically been a winning strategy… but it’s been a rough couple of years.
So… is value dead? Should we all just buy the S&P 500 and be done?
The rumors of value’s death have been greatly exaggerated. Larry Swedroe wrote am excellent piece on the subject this month, Don’t Give Up On the Value Factor, and I’m going to publish a few excerpts below.
As the director of research for Buckingham Strategic Wealth and The BAM Alliance, I’ve been getting lots of questions about whether the value premium still exists. Today I’ll share my thoughts on that issue. I’ll begin by explaining why I have been receiving such inquiries.
Recency bias – the tendency to give too much weight to recent experience and ignore long-term historical evidence – underlies many common investor mistakes. It’s particularly dangerous because it causes investors to buy after periods of strong performance (when valuations are high and expected returns low) and sell after periods of poor performance (when valuations are low and expected returns high).
A great example of the recency problem involves the performance of value stocks (another good example would be the performance of emerging market stocks). Using factor data from Dimensional Fund Advisors (DFA), for the 10 years from 2007 through 2017, the value premium (the annual average difference in returns between value stocks and growth stocks) was -2.3%. Value stocks’ cumulative underperformance for the period was 23%. Results of this sort often lead to selling.
Charles here. Other than perhaps overconfidence, recency bias is probably the most dangerous cognitive bias for the vast majority of investors. Investors look at the recent past and draw the conclusion that this is “normal” and representative of what they should expect going forward. This is why otherwise sane people do crazy things like buy tech stocks in 1998, Florida homes in 2005 or Bitcoin in late 2017.
Investors who know their financial history understand that this type of what we might call “regime change” is to be expected. In fact, even though the value premium has been quite large and persistent over the long term, it’s been highly volatile. According to DFA data, the annual standard deviation of the premium, at 12.9%, is 2.6-times the size of the 4.8% annual premium itself (for the period 1927 through 2017).
As further evidence, the value premium has been negative in 37% of years since 1926. Even over five- and 10-year periods, it has been negative 22% and 14% of the time, respectively. Thus, periods of underperformance, such as the one we’ve seen recently, should not come as any surprise. Rather, they should be anticipated, because periods of underperformance occur in every risky asset class and factor. The only thing we don’t know is when they will pop up.
After a period like the past ten years, it’s easy to draw the conclusion that value is dead. But investors drew the same conclusion in 1999… and they were dead wrong.
As a case in point, see Julian Robertson’s last letter to investors.
This article first appeared on Sizemore Insights as Is Value Dead?
Growth stocks — and specifically large-cap tech stocks led by the FAANGs — have utterly crushed value stocks of late. It’s been the dominant theme of the past five years. Even the first quarter of 2018, which saw Facebook engulfed in a privacy scandal, saw growth outperform value.
|Large-Cap Growth||S&P 500 Growth||1.58%|
|Large-Cap Stocks||S&P 500||-1.22%|
|International||MSCI EAFE Index||-2.19%|
|Utilities||S&P 500 Utilities||-3.30%|
|Large-Cap Value||S&P 500 Value||-4.16%|
|Real Estate Investment Trusts||S&P U.S. REIT Index||-9.16%|
|Master Limited Partnerships||Alerian MLP Index||-11.22|
Value stocks in general underperformed, and the cheapest of the cheap — master limited partnerships — got utterly obliterated.
So, is value investing dead?
Before you start digging its grave, consider the experience of Julian Robertson, one of the greatest money managers in history and the godfather of the modern hedge fund industry. Robertson produced an amazing track record of 32% compounded annual returns for nearly two decades in the 1980s and 1990s, crushing the S&P 500 and virtually all of his competitors. But the late 1990s tech bubble tripped him up, and he had two disappointing years in 1998 and 1999.
Facing client redemptions, Robertson opted to shut down his fund altogether. His parting words to investors are telling.
The following is the Julian Robertson’s final letter to his investors, dated March 30, 2000, written as he was in the process of shutting down Tiger Management:
In May of 1980, Thorpe McKenzie and I started the Tiger funds with total capital of $8.8 million. Eighteen years later, the $8.8 million had grown to $21 billion, an increase of over 259,000 percent. Our compound rate of return to partners during this period after all fees was 31.7 percent. No one had a better record.
Since August of 1998, the Tiger funds have stumbled badly and Tiger investors have voted strongly with their pocketbooks, understandably so. During that period, Tiger investors withdrew some $7.7 billion of funds. The result of the demise of value investing and investor withdrawals has been financial erosion, stressful to us all. And there is no real indication that a quick end is in sight.
And what do I mean by, “there is no quick end in sight?” What is “end” the end of? “End” is the end of the bear market in value stocks. It is the recognition that equities with cash-on-cash returns of 15 to 25 percent, regardless of their short-term market performance, are great investments. “End” in this case means a beginning by investors overall to put aside momentum and potential short-term gain in highly speculative stocks to take the more assured, yet still historically high returns available in out-of-favor equities.
There is a lot of talk now about the New Economy (meaning Internet, technology and telecom). Certainly, the Internet is changing the world and the advances from biotechnology will be equally amazing. Technology and telecommunications bring us opportunities none of us have dreamed of.
“Avoid the Old Economy and invest in the New and forget about price,” proclaim the pundits. And in truth, that has been the way to invest over the last eighteen months.
As you have heard me say on many occasions, the key to Tiger’s success over the years has been a steady commitment to buying the best stocks and shorting the worst. In a rational environment, this strategy functions well. But in an irrational market, where earnings and price considerations take a back seat to mouse clicks and momentum, such logic, as we have learned, does not count for much.
The current technology, Internet and telecom craze, fueled by the performance desires of investors, money managers and even financial buyers, is unwittingly creating a Ponzi pyramid destined for collapse. The tragedy is, however, that the only way to generate short-term performance in the current environment is to buy these stocks. That makes the process self-perpetuating until the pyramid eventually collapses under its own excess. [Charles here. Sound familiar? Fear of trailing the benchmark has led managers to pile into the FAANGs.]
I have great faith though that, “this, too, will pass.” We have seen manic periods like this before and I remain confident that despite the current disfavor in which it is held, value investing remains the best course. There is just too much reward in certain mundane, Old Economy stocks to ignore. This is not the first time that value stocks have taken a licking. Many of the great value investors produced terrible returns from 1970 to 1975 and from 1980 to 1981 but then they came back in spades.
The difficulty is predicting when this change will occur and in this regard, I have no advantage. What I do know is that there is no point in subjecting our investors to risk in a market which I frankly do not understand. Consequently, after thorough consideration, I have decided to return all capital to our investors, effectively bringing down the curtain on the Tiger funds. We have already largely liquefied the portfolio and plan to return assets as outlined in the attached plan.
No one wishes more than I that I had taken this course earlier. Regardless, it has been an enjoyable and rewarding 20 years. The triumphs have by no means been totally diminished by the recent setbacks. Since inception, an investment in Tiger has grown 85-fold net of fees; more than three time the average of the S&P 500 and five-and-a-half times that of the Morgan Stanley Capital International World Index. The best part by far has been the opportunity to work closely with a unique cadre of co-workers and investors.
For every minute of it, the good times and the bad, the victories and the defeats, I speak for myself and a multitude of Tiger’s past and present who thank you from the bottom of our hearts.
Charles here. The more things change, the more they stay the same. Value will have its day in the sun again, and that day is likely here with the FAANGs finally starting to break down.
Had Robertson held on a little longer, he would have been vindicated and likely would have made a killing. Consider the outperformance of value over growth in the years between the tech bust and the Great Recession:
So, don’t abandon value investing just yet. If history is any guide, it’s set to leave growth in the dust.
This article first appeared on Sizemore Insights as Keeping Perspective: Julian Robertson’s Last Letter to Investors
Tadas Viskanta, editor of the excellent finanical blog Abnormal Returns, asked a group of financial bloggers the following question:
Assume you are advising a pension fund, endowment or foundation. What is a reasonable long-term expectation for real returns for a well-diversified portfolio?
The answered varied, but it seems like the consensus was somewhere in the ballpark of 2%-3%, though some had estimates of 5% or better.
This was my response:
We all know the standard answer: stocks “always” return 7% to 10% per year. But while that might be true over a 20-30-year time horizon, the reality can be very different over shorter time horizons.
At today’s valuations, the S&P 500 is priced to actually lose 2%-3% per year over the next eight years. That estimate is based on historical CAPE valuations, which have limitations (including the failure to take into account differences in interest rates over time). So, let’s assume the CAPE is being unduly bearish given today’s yields and that stock returns end up being 5% better than the CAPE suggests. We’re still looking at returns of 2%-3%.
That’s roughly in line with with the yields you can achieve on a high-quality bond portfolio. So, core assets should return something in the ballpark of 2%-3% per year over the next 8-10 years. Overseas (and particularly emerging market) stocks might do significantly better than that, and commodities might enjoy a good decade starting at today’s prices. So, a diversified portfolio that included emerging-market stocks and commodities might post respectable returns. But a standard 60/40 portfolio is unlikely to return better than about 3% over the next 8-10 years.
There were some very solid, very thoughtful responses from several financial bloggers I respect and follow. To read the other answers, see Finance blogger wisdom: real returns.
This article first appeared on Sizemore Insights as Finance Blogger Wisdom: What’s a Reasonable Estimate for Portfolio Returns Going Forward?
It remains to be seen whether the market is in the midst of a garden-variety 10% correction or if this is the start of a deeper bear market. But it does seem like this market is being held aloft buy a small handful of large-cap tech stocks: the infamous FAANGs.
Let’s play with the numbers a little.
The S&P 500 cratered in early February but quickly rebounded, recouping about two thirds of its loss. And when the market rolled over again this month on trade fears, it stopped short of hitting new lows.
But stripping out tech and telecom stocks, we see a different picture. the S&P ex-Technology and Telecom Services Index fell in lockstep with the S&P 500, but the recovery was less robust. It recovered a little over half the prior losses. And when stocks dropped again in March, the ex-Tech and Telco fell to new lows.
Now, let me be clear that this is by NO means a thorough analysis. This is a superficial first scan, and I plan to dig deeper this week.
Furthermore, the data as presented here doesn’t specifically isolate the impact of the FAANGs. The S&P 500 ex-Technology and Telecom Services index actually includes one of the FAANGs — high flier Amazon.com (AMZN) — which makes its performance look better than it should. It also excludes stodgy old telecoms like AT&T (T) and Verizon (VZ), both of which have gotten obliterated this year as interest rates have risen… and which didn’t participate at all in the rally earlier this month. Excluding telco also makes the ex-tech index look better than it should.
I’ll dig deeper into the data later to build a true S&P 500 ex-FAANGs index, but this initial look would suggest that the this market is indeed narrow, being held aloft by Big Tech. That’s worrisome… and it makes me believe that more pain could be coming.
Disclosures: No positions in the stocks mentioned.
This article first appeared on Sizemore Insights as Are the FANGs Holding Up a Weak Market?
I always try to read everything that Jeremy Grantham’s GMO publishes, but I somehow missed this one until it was republished on Meb Faber’s Idea Farm. Good stuff: Don’t Act Like Stalin.
Lot’s of good takeaways (as always). GMO’s main point was that chasing recent performance is a game you can’t win. All good strategies (and good managers) have periods of outperformance and underperformance.
But while chasing performance is a terrible move, so is sticking with a bad strategy or a strategy that is likely to be a lousy fit in a given macro environment (i.e. owning bonds in an inflationary environment or owning gold and commodities in a severe disinflationary environment).
This is where communication is important. Talk to your manager and ask them to explain their strategy. If it’s outperforming, ask them why. If they can’t explain it (or if they get excessively cocky about it), I’d question how sustainable the performance is. You might want to bank your profits and move on.
Likewise, if they’re having a bad year, ask them why. If they can’t explain it, they get overly defensive or their answer just doesn’t make sense, don’t hesitate to cut them loose. But if their strategy makes intuitive sense to you and it offers diversification alongside other strategies you’re running (that great alchemy of uncorrelated returns!), then give the manager a little leeway.
Not for the manager’s benefit, of course. His or her wellbeing is not your concern. But if you employed them for a reason (i.e. their strategy tends to zig while the rest of your portfolio zags) then you should hang on long enough to get the expected benefit.
As a case in point, Grantham and his team lost half their assets under management in the late 1990s when value lagged growth. But Gratham absolutely killed it in the years following the tech crash… and his former clients that bailed on him missed out.
This article first appeared on Sizemore Insights as Don’t Invest Like Stalin
Prospect Capital’s (PSEC) latest earnings release didn’t do much to improve investor sentiment toward the stock. It remains mired in trading range and sits are barely 70% of book value.
PSEC has long been accused of being a little more aggressive than its peers in valuing its assets. But even so, at these levels it is safe to say that Prospect is trading at a deep discount to the value of its underlying portfolio.
We all know it’s a tough market for business development companies. Funding costs are rising at a time when yields on investment are falling due an glut of capital in the space.
So, here’s a novel idea for management: Halt all new investment and instead plow the proceeds into share repurchases.
I’m not joking. Prospect shares yield 11% at current prices, which is about in line with its new originations. But it also trades at a 28% discount to book value and is diversified. So why accept the risk of a new origination if you can simply reinvest in your own shares and be done?
This article first appeared on Sizemore Insights as Prospect Capital’s Valuation Still In the Dumps
With market volatility picking up this past week, now is as good a time as any to review why it’s important to take your losses early.
|Portfolio Loss||Gain Required to Break Even|
If you lose 10%-20% in a trade, it’s not that hard to recover. It only takes 11% – 25% to get back to where you started.
But if you lose 50%, you need 100% returns to get back to break even. Or if you lose 97% — as Bill Ackman recently did in Valeant Pharmaceuticals — you’d need a ridiculous 3,233% on your next trade just to get back to zero.
I have a select few stocks in my portfolio that I’m truly willing to buy and hold, tolerating whatever volatility the market throws at me. As an example, I own some shares of Realty Income (O) that I will never sell. I’m reinvesting the dividends and letting them compound, and I’m willing to sit through a significant drawdown.
But for the lion’s share of my portfolio, I take my losses early. I’ve taken enough losses over the years to learn that lesson the hard way…
This article first appeared on Sizemore Insights as Take Your Losses Early and Often
Warren Buffett is a hero to many investors, myself included. His record speaks for itself: 18.3% annualized returns in Berkshire Hathaway’s ($BRK-A) book value over the past 30 years compared to just 10.8% for the S&P 500. And his returns in the 1950s and 1960s, when he was running a much smaller hedge fund, were even better.
Mr. Buffett is also quite generous with his investment wisdom, sharing it freely with anyone who cares to listen. But as with most things in life, failure is a better teacher than success. And Mr. Buffett has had his share of multi-billion-dollar failures.
You want to know the biggest mistake of Buffett’s career?
By his own admission, it was buying Berkshire Hathaway!
Everyone assumes that Buffett’s decision to buy Berkshire Hathaway was a typical Buffett stroke of genius. Nothing could be further from the truth.
We like to think of Warren Buffett as the wise, elder statesman of the investment profession, but Buffett too was young once and prone to the rash behavior of youth. And Berkshire Hathaway was not always a financial powerhouse; it was once a struggling textile mill.
Buffett had noticed a trading pattern in Berkshire’s stock; when the company would sell off an underperforming mill, it would use the proceeds to buy back stock, which would temporarily boost the stock price. Buffett’s strategy was to buy Berkshire stock each time it sold a mill and then sell the company its stock back in the share repurchase for a small, tidy profit.
But then ego got in the way. Buffett and Berkshire’s CEO had a gentleman’s agreement on a tender offer price. But when the office offer arrived in the mail, Buffett noticed that the CEO’s offer price was 1/8 of a point lower than they had agreed previously.
Why? Because Buffett wasted precious time and capital on a textile mill in terminal decline rather than allocate his funds in something more profitable—in his case, insurance.
By Buffett’s estimates, had he never invested a penny in Berkshire Hathaway and had instead used his funds to buy, say, Geico, his returns over the course of his career would have been doubled. Berkshire will still go down in history as one of the greatest investment success stories in history, of course. But it was a terrible investment and a major distraction that cost Buffett dearly in terms of opportunity cost.
What lessons can we learn from this? I’ll leave you with two quotes from Buffett himself:
“If you get into a lousy business, get out of it.”
“If you want to be known as a good manager, buy a good business.”
In trader lingo, cut your losers and let your winners ride. Holding on to a bad investment wastes good capital and mental energies that would be better put to use elsewhere.
Thank you, Mr. Buffett, for sharing your failures with us. Your willingness to do so is one of the reasons we love you.
I originally penned this articled in December 2011. Given Sears’ stock action in the year that has passed, it’s worth another read.
A well-respected value investor buys an old American company in decline, promising to restore its fortunes. Alas, the recovery never comes. The economics of the industry have changed, and the company cannot compete with younger, nimbler rivals. The company ceases operations, but the value investor holds onto the shell to use as an investment vehicle.
Could this be the future of Sears Holdings (Nasdaq: $SHLD) under Eddie Lampert? Maybe; maybe not. But it was certainly the case for Warren Buffett’s Berkshire Hathaway (NYSE: $BRK-A).
Unless you’re a history buff or a dedicated Buffett disciple, you might not have known that Berkshire Hathaway was not always an insurance and investment conglomerate. It was a textile mill, and not a particularly profitable one. It was, however, a cash cow. And after buying the company in 1964, Buffett used the cash that the declining textile business threw off to make many of the investments he is now famous for, starting with insurance company Geico.
So, when hedge fund superstar Eddie Lampert first brought Kmart out of bankruptcy in 2003, the parallels were obvious. With its debts discharged, the retailer would throw off plenty of cash to fund Lampert’s future investments. And even if the retail business continued to struggle, Lampert could—and did—sell off some of the company’s prime real estate to retailers in a better position to use it. Lampert sold 18 stores to the Home Depot (NYSE: $HD) for a combined $271 million in the first year.
That Lampert would use Kmart’s pristine balance sheet to purchase Sears, Roebuck, & Co.—itself a struggling retailer—seemed somewhat odd, but his management decisions after the merger seemed to confirm that his strategy was cash cow milking. Lampert continued to talk up the combined retailer’s prospects, of course. But his emphasis was on relentless cost cutting, and he invested only the absolute bare minimum to keep the doors open. Sears Holdings didn’t have to compete with the likes of Home Depot or Wal-Mart (NYSE: $WMT). It just had to stay in business long enough for Lampert to wring out every dollar he could before selling off the company’s assets.
The strategy might have played out just fine were it not for the bursting of the housing bubble—which killed demand for the company’s Kenmore appliances and Craftsman tools—and the onset of the worst recession in decades. With retail sales in the toilet (and looking to stay there for a while), there was little demand among competing retailers for the company’s real estate assets.
It’s fair to blame Lampert for making what was, in effect, a major real estate investment near the peak of the biggest real estate bubble in American history. But investors frustrated by watching the share price fall by more than 80 percent from its 2007 highs have no one to blame but themselves. Anyone who bought Sears when it traded for nearly $200 per share clearly didn’t do their homework. They instead were hoping to ride Lampert’s coattails while somehow ignoring the value investor’s core principle of maintaining safety by not overpaying for assets.
Lampert is a great investor with a great long-term track record, and there is nothing wrong with paying a modest “Lampert premium” for shares of Sears Holdings. If you like Lampert’s investment style but lack the means to invest in his hedge fund, Sears may be the closest you can get. But at $200 per share—or even $100—the Lampert premium had been blown completely out of proportion. The same is true of Buffett, of course, or of any great investor. As the Sage of Omaha would no doubt agree, there is a price at which Berkshire Hathaway is no longer attractive either.
This brings us back to the title of this piece—is Sears the Next Berkshire Hathaway?
I would answer “yes,” but not necessarily for the reasons you think.
Everyone assumes that Buffett’s decision to buy Berkshire Hathaway was a typical Buffett stroke of genius. Nothing could be further from the truth. In fact, Buffett revealed in an interview last year that Berkshire Hathaway was the worst trade of his career.
If you cannot view the video above, please follow this link: “Buffett’s Worst Trade“
We like to think of Warren Buffett as the wise, elder statesman of the investment profession, but Buffett too was young once and prone to the rash behavior of youth. He had been trading Berkshire Hathaway’s stock in his hedge fund; he noticed that when the company would sell off an underperforming mill, it would use the proceeds to buy back stock. Buffett intended to sell Berkshire Hathaway its own stock back for a small, tidy profit.
But due to a tender offer that Buffett took as a personal insult, he essentially bought a controlling interest in the company so that he could have the pleasure of firing its CEO. And though it might have given him satisfaction at the time, Buffett called the move a “200-billion-dollar mistake.”
Why? Because Buffett wasted precious time and capital on a textile mill in terminal decline rather than allocate his funds in something more profitable—in his case, insurance. Berkshire Hathaway will still go down in history as one of the greatest investment success stories in history. But by Buffett’s own admission, he would have had far greater returns over his career had he never touched it.
So, in a word, “yes.” Sears probably is the next Berkshire Hathaway. And investors who buy Sears at a reasonable price will most likely enjoy enviable long-term returns as Lampert’s plans are eventually realized. But Mr. Lampert himself will almost certainly come to regret buying the company—if he doesn’t already.