“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Thus did Benjamin Graham, the godfather of value investing, distinguish between the “business” of investing and the“‘game” of speculation.
All investing is value investing
In his attempt to define the difference between investment and speculation, we don’t think Graham was casting moral judgments upon speculators, so much as simply trying to codify the nature of capital allocation and define some of the ground rules.
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We have no problem with shorter-term speculation either. Indeed we incorporate it within our bespoke managed account service in the form of systematic trend-following managers.
We would argue that there are, in essence, only really two ways of attempting to secure enhanced returns versus the market itself with any reasonable chance of success. One is “value investing”, which we would define briefly as “obtaining superior cash flows cheaply”.
The other is “momentum investing”. That is, exploiting the various price trends manifest in markets, but doing so without any concern as to underlying valuation during the process (albeit incorporating a defined algorithmic approach and a selection of standardised rules in the context of price evolution, position sizing and risk management).
Pretty much everything else, we would argue, comes down to gambling.
That said, according to much of the financial media, “value investing” has been dead for years. So perhaps we should define, or redefine, our terms. As Joel Greenblatt puts it: “All investing is value investing. The rest is speculation.”
Fund management practitioners, especially after having garnered a few billion by way of assets, start to hawk adjectives around: “growth”, “value”, and so on. This enables them to market even more types of funds and garner even more assets.
But the only essential distinction then comes down to what Graham called a “margin of safety”: the characteristic that a listed share, for example, possesses when it is bought for less than the underlying business is intrinsically worth.
The one characteristic that value investors need above all others
As discretionary investment managers, we seek to protect and grow the irreplaceable capital of our clients using the broadest range of diverse investments available to us.
Because of the secular distortion of capital markets and valuations inflicted by clueless inflationists at the world’s central banks, we consciously focus on “margin of safety” because we do not wish to incur the significant drawdowns that inevitably come from overpaying for poor quality investments.
We complement these holdings of “value” shares (ie, superior cash flows bought at a discount, ideally being generated by companies with little or no attendant debt) with real assets (notably the monetary metals, gold and silver, and related companies with the same attributes of superior cash-flow generation and no debt).
We diversify further with systematic trend-following funds that can be confidently predicted to possess little or no outright price correlation with the world’s stock or bond markets.
The value stocks are a claim on the real economy and on human ingenuity. The real assets are a hedge of sorts against politicians. The uncorrelated funds are a hedge against our own overconfidence.
In reading the output of the mainstream media (never a good idea), one might be forgiven for concluding that, over recent years, speculators chasing growth stocks have made out like bandits while value managers have been haemorrhaging capital through their eyeballs.
The reality is that any value managers worthy of the name have simply made less money than they might have done by owning stocks such as Facebook, Amazon, Netflix and Tesla.
We have been content with the returns of our own equity portfolio, and we haven’t bought stocks in companies that we consider either wildly overpriced, fraudulent or, in some notorious instances, probably both.
The “wrinkle” with legitimate value investing is that, as Keynes correctly observed, markets can remain irrational longer than market participants can remain solvent. The solution, we humbly suggest, is to combine a defensive posture with patience.
As the value manager Peter Cundill once observed: “The most important attribute for success in value investing is patience, patience, and more patience. The majority of investors do not possess this characteristic.”
• Tim Price is manager of the VT Price Value Portfolio (pricevaluepartners.com) and author of Investing Through the Looking Glass: a Rational Guide to Irrational Financial Markets.
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