Tag Archives: valuewalk

Seth Klarman On Value Investing In A Turbulent Market

Investors must employ an investment philosophy and process that serve as a bulwark against a turbulent sea of uncertainty and then navigate through confusing and often conflicting economic signals and market head fakes. Amidst the onslaught of gyrating securities prices, fast and furious corporate developments, and an unprecedented volume of data, it is more important than ever to maintain your bearings. Value investing continues to be the best (and perhaps only) reliable North Star for those who are able to remain patient, long-term oriented, and risk averse.” – Seth Klarman year-end 2015 letter to investors. 2015 was a bad year for Seth Klarman and his Boston-based hedge fund Baupost. The fund lost money for its investors, a rare event – it’s only happened three times since the fund’s founding in 1982. Click to enlarge Off the back of such a terrible performance, Seth Klarman devoted the majority of his year-end letter to investors explaining that value investing isn’t a precise science in his usual calm and philosophical manner. It’s unlikely that Klarman would have been aware what was in store for the markets in the first few months of 2016, but as it turns out, his words couldn’t have come at a better time for value investors seeking reassurance in a turbulent market. Seth Klarman: Take advantage of Mr. Market Value investors gain clarity by thinking about their investments not as quoted stocks whose prices whip around on a daily basis, but rather as fractional ownership of the underlying businesses.” – Seth Klarman year-end 2015 letter to investors . To be a successful investor, you must be able to take advantage of Mr. Market’s bipolarity. You must be able to step in and buy shares when Mr. Market offers them to you at a knock-down price, but you need to be able to ignore his calls to sell at lower levels. Klarman writes that the two extremes of human nature, fear and greed drive market inefficiency. Fear is primal, the effect of confronting the apparent loss of what you have. Your shares still represent the same fractional ownership in a business as when they traded higher yesterday, however, people are now en masse delivering the verdict that your shares are actually worth less. You have to find a way not to care or even to relish this eventuality. Warren Buffett has written that one should not invest in stocks at all if uncomfortable with the possibility of a 50% drawdown. The mistake some investors make is to accept the market’s immediate verdict as fact and not opinion, and become disappointed, even frustrated.” — Seth Klarman year-end 2015 letter to investors . Losses can cause people to lose their bearings. It’s natural to want to sell everything after your portfolio has been marked down sharply. Watching your net worth evaporate in front of you as the market falls isn’t a pleasant experience. However, this is the wrong way of thinking about equities. Klarman writes that for an investor to overcome the desire to sell at the bottom and take advantage of Mr. Market’s erratic movements, they must think not about what the market will pay for the securities today, (the stock price) but rather the true value of the securities you own based on such attributes of the underlying businesses as free cash flows, private market values, liquidation values, downside protection, and growth prospects. Klarman continues, saying that when the market, in the absence of adverse corporate developments, drives an undervalued security down in price to become an even better bargain, that’s not a reason for panic, or even for mild concern, but rather for excitement at the prospect of adding to an already great buy. When tempted to sell: Investors must think not only about what they would be getting (the end of pain that accompanies the certainty of cash) but also what they’re giving up (a significantly undervalued security which, emotion aside, may be a far better buy than a sell at today’s market price).” – Seth Klarman year-end 2015 letter to investors . This is why conducting your own rigorous due diligence is essential. The insights gained from due diligence give you the justifiable confidence to maintain your bearings – to hold on and consider buying more – even on the worst days in the market. Seth Klarman: Don’t be greedy Greed works alongside greed to eat away at your confidence and push you to make decisions that are hazardous to your wealth. The angst felt when others are succeeding while you are not can lead you to make poor decisions, on this topic Klarman cities J.P. Morgan, who said “Nothing so undermines your financial judgment as the sight of your neighbor getting rich,” and Gore Vidal who dryly noted, “Whenever a friend succeeds, I die a little.” What’s more, the fear of missing out can be a kill switch for risk aversion in that it tempts people into paying up and then holding on too long. Fear of missing out, of course, is not fear at all but unbridled greed. The key is to hold your emotions in check with reason, something few are able to do. The markets are often a tease, falsely reinforcing one’s confidence as prices rise, and undermining it as they fall. Pundits often speak of the psychology of markets, but in investing it is one’s own psychology that can be most dangerous and tenuous.” – Seth Klarman year-end 2015 letter to investors . To show just how dangerous (and damaging) fear and greed can be to investors’ returns, Klarman lets the figures do the talking. The data shows that over the 30-year period from 1984 to 2013, the S&P 500 Index returned an annualized 11.1%. However, according to Ashvin Chhabra, head of Euclidean Capital and author of ” The Aspirational Investor ,” the average returns earned by investors in equity mutual funds over the same period was ” a paltry 3.7% per year, about one-third of the index return .” Bond investors were dealt even more pain. While the Barclays Aggregate Bond Index returned an annualized 7.7% over the 30-year period from 1984 to 2013, bond funds produced an annualized return of 0.7%. The underperformance in both cases was a direct result of investors pulling money out of the funds at precisely the wrong times. In short, by letting fear and greed take over their emotions, retail investors have underperformed both the markets and the very funds in which they were invested since 1984. That’s a statistic that’s difficult to ignore. So to conclude: In the moment, public market investors have no ability to control investment outcomes, but they can control and improve their own processes. We never shoot for high near-term investment returns. Trying too hard to earn positive results, or assessing performance too frequently, can drive anyone into short-term thinking, herd-like behavior, and incurring higher risk…We believe that by remaining focused on following a well-conceived process, we will make good risk-adjusted, long-term investments. And we know that if we do that, we will indeed earn good returns over time.” – Seth Klarman year-end 2015 letter to investors. Disclosure: None.

Be A Proactive Investor

During volatile times in the market, like what we have been experiencing since May, it’s difficult to see through the disparaging news headlines (Oil is Collapsing! Bear Market in Stocks! US Is In A Recession!) and to not lose the forest for the trees. Investing is a long-term game with seemingly unlimited number of opportunities and it’s imperative as an investor to not get caught up in the day-to-day swings (and explanations) of the stock market. It’s times like this where a word like “casino” gets tossed around as a synonym for the stock market. And you know what, in the short run, the market is a lot like a casino. One day the market is up, the next day the market is down. Don’t believe me since it feels like the market has been down a whole lot more than it has been up lately? Well, would you be surprised to know that over the past 200-days developed world equities have been up 47% of the days and down 53% of the days. Pretty close to a 50-50 coin flip, right? Percentage Of Positive Performance Days For Stocks Proactive Investor But long-term investors know that the stock market isn’t really like a casino at all. The “payoff odds” in the stock market are not static like they are in a casino. Hitting the right number in roulette will always pay 35:1 but investing in the right stock could return 10% or it could return 10,000%. Therefore, it’s key to think of investing in terms of probabilities instead of binary outcomes. Investing is not about calling the top or bottom in the market exactly right. It’s about understanding if there are more positive investment opportunities in the market than there are negative opportunities (or vice versa). Put another way, it’s about properly identifying where the market currently falls on the risk/reward spectrum. This way, you as an investor can be proactive rather reactive to changes in the market. We have known for quite some time that this is the longest running cyclical bull market in a secular bear market , so a selloff like the one we are in now was bound to happen sometime. And in the long term, that is actually great news for investors because future returns have undoubtedly improved thanks to the opportunity to buy stocks on “sale.” But this is where investor psychology really comes into play. If your risk antennae was not tuned up to the fact that the probability of a selloff had increased (i.e. the opportunity set had shifted from more buying opportunities to more selling opportunities), then it’s really difficult to realize after a 15-20% decline that the opportunity set is ALREADY shifting again back into your favor. You are reacting to the declining market and when you are reacting, it’s hard to make the correct rational decision. To sell stocks into a declining market is always hard because in the back of your mind you know you missed out on the optimal time to get out and it’s so easy to tell yourself “I’ll sell out of stock XYZ just as soon as it rises 5-10%.” Of course, in a slide like we are in now, it’s very rare for the market to ever give you that 5-10% gain, and so you sit on the underperforming stock far longer than you would have liked. However, if an investor is proactive in identifying where we currently sit on the risk/reward spectrum, there is a very good chance that that investor had begun to shift his or her portfolio into more defensive sectors and perhaps into cash as well. While they would have been undoubtedly early and missed out on some of the gain back in May, they are already mentally prepared to begin to take advantage of some of the positive opportunities that are presenting themselves in this correction. This is why at Gavekal Capital, we focus so much on risk management. Yes, risk management is about protecting the downside. But more so, it’s about being proactive in your investment process so that when the risk/reward spectrum flips in your favor you are ready to take advantage of it and capture the gains in your portfolio. Disclosure: None.

Simple Investing Strategies Cannot Remain Entirely Simple For Long

By Rob Bennett Simple investing strategies are sound investing strategies. The key to success is sticking with a strategy long enough for it to pay off. Complex strategies cause investors to lose focus. Unfocused investors have a hard time sticking with their strategies through dramatic changes in circumstances. The greatest virtue of Buy-and-Hold is its simplicity. However, Buy-and-Hold purists take the desire for simplicity too far. Buy-and-Holders have told me that one big reason why the strategy was not changed following Robert Shiller’s “revolutionary” (his word) finding that valuations affect long-term returns is that it would complicate it to add a requirement that investors adjust their stock allocations in response to big valuation shifts in an effort to keep their risk profiles roughly constant. If that’s so, they made a terrible mistake. Buy-and-Hold does not call for allocation adjustments to be made in response to valuation shifts because the research showing the need for them did not exist at the time the Buy-and-Hiold strategy was being developed. Once the strategy was set up in the way that it was, changing allocations came to be seen as a complication. Isn’t it more simple to stick with one allocation at all times? I don’t think so. Buy-and-Hold seemed simple in the days when we did not realize how much the long-term value proposition of stocks is altered by the valuation level that applies at the time the purchase is made. We now know that the investor who fails to make allocation adjustments is thereby permitting his risk profile to swing wildly about as valuations move from low levels to moderate levels to high levels. In the long term, there is more complexity in a strategy that calls for wild risk profile shifts than in one that requires the investor to check valuation levels once per year and to change his stock allocation once every ten years or so. That’s all that is required for investors seeking to keep their risk profiles roughly stable. That extra one hour or so of work performed every decade reduces the risk of stock investing by 70 percent and saves the investor a lot of emotional angst during price crashes. It is the losses suffered in price crashes that cause investors to abandon Buy-and-Hold strategies (at the worst possible time!). Devoting an additional one hour of work to the investing project renders price crashes virtually painless for investors following the updated Buy-and-Hold approach (Valuation-Informed Indexing). It’s not only engaging in transactions that adds complexity. Figuring out how to respond when large losses of accumulated wealth are experienced is a huge complication, one that Buy-and-Holders did not consider when devising the first-draft version of the strategy. There are other ways in which Buy-and-Hold has become more complicated over the years. In the early days, there were few types of index funds available. Investors were generally advised to go with a Total Stock Market Index Fund. That’s still a good choice. But today’s investor has dozens of options available to him. He can invest only in small caps or only in mid caps or only in large caps or can mix or match in all sorts of ways. Traditionalist Buy-and-Holders often express dismay at the number of choices available, bemoaning the added complexity that comes with added options. I am sympathetic to those feelings. The core Buy-and-Hold idea – that it is by keeping it simple that investors avoid falling into emotional traps and confusions – is an idea of great power. Purchasing a Total Stock Market Index Fund still makes a great deal of sense for the typical, average investor. But I don’t believe that dogmatism on this question is justified. It adds only a limited amount of complexity for an investor to focus on small caps or large caps or mid caps. And some investors find appeal in focusing their investing dollars in the ways that new types of index funds permit. Some investors don’t feel safe investing in anything other than large caps. Some like the excitement of small caps and would be inclined to try to pick individual stocks rather than to index if investing in a Total Stock Market Index Fund were the only available option. In relative terms, an investor who purchases a large cap index fund or a small cap index fund or a mid cap index fund might thereby be avoiding more complex options that would draw him in if he were to try to follow a purist path. And of course many investors like to invest in different segments of the market. Investing in a high-tech index fund is riskier than investing in a broad index fund. But it is less risky than investing in any one high-tech company. Buy-and-Hold dogmatics would argue that only the investor who chooses a broad index fund is a true Buy-and-Holder. My take is that the success of the Buy-and-Hold strategy inevitably created demand for a greater variety of investing options and that there is no way to keep the Buy-and-Hold concept from becoming a bit more complicated over time. Another big change since the early days of Buy-and-Hold is that many investors no longer limit themselves to broad U.S. indexes but seek participation in the global marketplace. That makes sense, doesn’t it? Our economy is gradually becoming a global economy. There are numerous complexities that come into play as the transition proceeds. The U.S. has long had a stable economic system. So going global adds risk. However, that might be true only historically and not on a going-forward basis. It might be that the risky thing on a going-forward basis is to continue to invest solely in the U.S. market. The Buy-and-Hold Pioneers did not anticipate having to make decisions re such questions. They thought they had solved the complexity problems once and for all. These questions just turned up as time passed. The full reality is that they always do! Simple investing strategies cannot remain entirely simple for long. Valuation-Informed Indexing will become more complex over time too. We have 145 years of U.S. stock market data available to us today to determine when valuations have changed enough to require an allocation adjustment and how big a allocation adjustment is required. As more years of data are recorded, our understanding of what sorts of allocation adjustments are either needed or desired will become sharpened and refined. That’s good. We want to have as much historical data available to us for guiding our allocation shifts as possible. But it cannot be denied that the decision-making process will become somewhat more complex as more considerations are taken into account. That’s just the way of the world. Humankind’s understanding of the world about it improves over time and those improvements undermine our ability to keep things simple. Simple is good. But a purist stance is not realistic in the fast-changing (because it is fast improving!) world in which we live today.