A few weeks ago I wrote about the weird way in which all fund managers consider themselves to be value-investing contrarians. (Read Merryn's article here: Should contrarian investors avoid commodities?) The fact that so few actually are is made clear by all the hoo-ha surrounding the retirement of Anthony Bolton, who has been managing Fidelity's Special Situations fund since 1979, and over that time has managed to turn an initial investment of £9,000 into £130,000.
I've heard a great many fund managers over the years saying they invest in the same sort of way as Bolton, but if they really did we'd probably hear a great deal less about how unique Bolton's performance is. The same is true of those who style themselves after America's famous value investor Warren Buffett.
I've lost count of the number of articles I've read proclaiming some fund manager or the other as the new Buffett, and of the number of managers I've spoken to who tell me they follow the same principles as him. But, despite all the talk, I've never come across one with the same kind of performance record Buffett is certainly the only money manager around in a position to give £20 billion to charity.
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Value investing: look at fundamental values
The principle of value investing as practised by Bolton and Buffett is hardly complicated. It's based on the idea that the market is not (as conventional theory has it) efficient. Instead, it is constantly distracted by "noise" of one sort or another.
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In the short and even medium term the prices of equities can move substantially in directions and for reasons that have little to do with their fundamental values, something that makes it likely if they have fallen that they will then offer better than average returns as they return to their correct value.
So all the value investor has to do in the long term is to find shares that have seen their prices fall for no good fundamental reason and hold on to them until that situation rights itself. This sounds so easy that one wonders how it can be that none of the would-be Buffetts seem able to manage it.
The answer comes down to the fact that one needs more than just knowledge to succeed. In a recent paper, James Montier of Dresdner Kleinwort, an investment bank, listed the characteristics that the best value investors have in common.
Value investing: have a concentrated portfolio
They have very concentrated portfolios (holding only about 35 stocks and having 40% of their portfolios in the top 10); they don't think they need to know everything so don't get caught in the noise of the market; they are willing to hold large amounts of uninvested cash if they can't find good opportunities; they have long time horizons (the average fund manager holds a stock for a year, the successful value investors Montier looked at held them for an average of over five years); and they accept bad years as being only to be expected rather than a reason to change their methods.
These are not things that an average fund manager is up to doing. To have a heavily concentrated portfolio rather than one so diversified that the individual performance of each share is almost irrelevant requires a strong nerve. Holding large amounts of cash also requires a degree of nerve: most fund managers are only prepared to take a relative view on the market (which stock is better than another stock), not to make the leap to taking an absolute view (deciding when cash is better than stocks).
Value investing: have the courage of your convictions
It is also a mark of the supremely confident to not want to know everything. While the rabble bury themselves in data, trying to forecast minute changes in quarterly earnings numbers, the real value investors focus on a few key bits of data and leave it at that.
Having the courage of your convictions to enable you to hold a stock you feel is underpriced for the long term, regardless of short-term performance, is also something most of us simply couldn't bear to do. Not so the successful value investor: while they may do well over the long term, notes Montier, having three down years in a row is far from unusual for them.
All in all it seems that doing well as a value investor is as much about having a certain type of character as it is about understanding investment, if not more so. Buffett habitually presents himself as a folksy grandpa type and Bolton comes across as a charmingly cerebral kind of gent, but behind their kindly smiles are clearly cores of steel something that most of us just don't have.
Value investing: shares to look at now
If we did we'd all have had a much calmer summer. And what would we be doing now? First I think we'd be recognising that there are few real value propositions left in the market (companies whose shares are trading at prices lower than the book value of their assets, for example).
We might look at shares in Wm Morrison: they've risen recently on takeover talk but still trade on a price to book ratio (the share price against the value of the company) of only 1.49 times (the supermarket firm owns vast amounts of freehold property) against Tesco's 2.7 times. And consider Luminar, the nightclub and restaurant company, where shares are trading on a price to book ratio of a mere 1.07 times.
Other than that I have to repeat that Shell and BP are still far too cheap and, as good value investors know, there's nothing wrong with holding cash.
By Merryn Somerset Webb, as first published in The Sunday Times (09/07/2006)
For more on Warren Buffett's investment style, see: How to invest like Warren Buffett; and Warren Buffett isn't buying American - should you?
