I had the privilege of sitting in on an interesting conversation between two value investors last week. Both are steeped in the Ben Graham school of bottom-up fundamentally-driven stock picking. Both run funds or strategies with the mandate of being long-only and fully invested in US equities.
Both are forced to endure markets like the one we’re in while operating outwardly as though their abilities matter in the short-term. In the quotes below (some paraphrased), I give you a sense of how they convince themselves that they’re adding value in the present tense, mostly because for the sake of their careers, they have to.
“I was trained to buy the companies that just reported good quarters in an environment like this, because they should be the first to turn.”
“I go the other way, I’m looking for the stocks that got the cheapest, the fastest, because it’s the real discounts that buyers will be hunting down first.”
“So then you’e probably looking at the industrials…”
“Yes, you have to be buying the industrials on a yield basis though, because if the cycle already peaked, you have nothing else to go on.”
“Because I’m not allowed to hold cash, one strategy I use is to look for companies that have huge amounts of cash on their balance sheet. To me, it’s the closest equivalent to actually holding that cash myself in the portfolio. The thinking is that those managers will eventually take advantage of lower market prices with that cash to do buybacks or acquisitions.”
“I can’t believe how much valuations for healthcare stocks have just come down on practically zero fundamental change. It’s totally unjustified.”
“But was the prior run-up in valuations on practically zero fundamental change totally justified? Because sentiment shifts work both ways…”
“I try to focus on management and get a sense of their outlook for their own business. Things are probably not as bad as the stock market portrays them to be.”
“The staples and utilities are a good place to hide out, paradoxically, even though they’re the opposite of ‘good values'” If I do that now, I keep my investors calm. But I probably underperform if and when this thing turns or the storm passes.”
“That’s the thing – we always have to balance the need to take risks today that look dumb but will pay off with the need to show less volatility than the overall tape.”
Josh here – I genuinely feel for people who have this long-only, stock-picking mandate when the market slides into a bear phase. It seems a bit like appraising the quality of fixtures and furniture on the Titanic.
In the intermediate to long-term, of course some of this research and positioning will pay off – but what is its real value for investors in the grand scheme of things? Is it worth the aggravation and the effort? If everything is going to succumb and slide downhill in the end, why put so much time and effort into which pair of skis are going to take you there?
And then I think about the end-investor in these types of strategies – does the knowledge that they own the names with the best CEOs or the lowest PEG ratios do anything to keep them calm and focused on the long-term? My experience tells me that it does not. High quality funds get redeemed right alongside low quality funds, regardless of the efforts being made internally by the PMs who run them.