Nov 27, 2007
The Follies of Value Investors
Value Investor Arrogance?
As value investors I feel we should be very humble. It’s an example that I see has been set by Warren Buffett, who we owe much of our investing knowledge to. Unfortunately, I don’t see this being demonstrated very well. Instead I see an abundance of childish commentary focused on bashing other forms of investing.
Lately I read the usual value investor message boards, and I see the same kinds of posts over and over where value guys feel the need to make disparaging remarks about other trading strategies. This was best demonstrated on the MSN Berkshire Hathaway board, where I encountered a post criticizing funds such as SAC Capital, Citadel Investment Group, and Renaissance Technologies for having a large number of employees.
To ridicule these firms is absolutely perplexing to me. Renaissance Technologies has held a very strong track record of 38% returns annually AFTER fees since 1989. I’d say the hundreds of scientists who are employed at Renaissance have been well worth it! SAC and Citadel also boast strong track records of beating the S&P. Additionally, these firms typically trade in a number of different strategies, offering the ability to possibly weather market changes that can be adverse to value investors.
I will never utilize technical analysis or quant trading strategies, but I have met people who have been very successful with these trading techniques. They do not use the cookie cutter techniques you get from a trading workshop you shell out thousands of dollars for, but make their own successful systems.
Many value investors like to use the term “circle of competence” when referring to fields they understand and are capable of investing in. I would say that something like TA is simply outside of my circle of competence. It may work, it may not work. I don’t know, I don’t choose to make negative remarks about it because I’ve seen great investors such as Paul Tudor Jones make a fortune with it. Some would argue that Jones was lucky, and maybe that’s the case, but I don’t think we can really tell either way. We should simply look the other way and make no comment on these types of strategies. Most of us have not practiced them and thus have no real experience to back up our thoughts.
Value Investing With a Limited Pallet
The other attitude I’ve observed which disturbs me is an extremely limited “circle of competence.” To give an example, at the moment we are seeing a number of financials plunge in value, but many investors claim that they do not understand these companies and would rather invest in something like Berkshire Hathaway, in order to take advantage of Buffett’s superior investing knowledge over their own.
If you’re focused on allocating a large amount of capital towards an investment, then I see this as being a satisfactory way to invest since it keeps preservation of capital on the forefront. However, people like Buffett and Munger will not be around forever. If you keep an attitude that you wont invest in financials, or companies in other seemingly complex situations, you not only limit what you invest in, but you limit your knowledge as an investor. You will then never seek to actually learn about these situations because you automatically assume it is too complex and would rather invest in another manager.
As investors, we should be trying to learn as much as possible every day. Automatically passing on doing any research of an investment situation because it is overly complex strikes me as something that would inhibit your learning and hurt you in the long run. This is why I prefer to invest in companies that do not have major investment arms, because it motivates me to be more self-reliant on my own analytical skills, than coasting off of Warren Buffett, Prem Watsa, Francis Chou, or Sardar Biglari.
Your thesis for investing should not be because billionaires/investment gurus own a company. Rather, your investment should be due to extensive bottom up research that gives you the evidence to support your thesis that the company is undervalued.
Some readers might find this contradictory since I have invested in Fairfax Financial Holdings, but my investment here was really to give me exposure to their CDS portfolio. From my analysis, FFH is undervalued, is well run, and the HWIC makes great investments. But the catalyst which made this company a buy for me was their CDS exposure. Looking at where their swap positions are at the moment, I believe I’ve made the right choice. If I had been a bigger investor, with better brokerage resources, I would have certainly tried to short certain mortgage securities or purchase swaps myself. Doing so would have used my original investment thesis, but would have potentially offered larger returns, as you can see here.
I am a strong supporter and believer in value investing, but I do hope these attitudes change in the future. Having an open mind is one of the most powerful assets that we can have as investors.
Good post. While value guys are generally the most egregious examples of style elitism, including comments like Merkel’s “TA doesn’t work” (in comments to Portfolio) and going all the way back to Ben Graham making flawed “straw man” arguments against other styles in The Intelligent Investor, there are examples from other sytles.
Just a few: The quant who says “if you think you can learn something useful from talking to management, then I have nothing to say to you,” or James Altucher making “straw man” arguments about the value style in Trade Like A Hedge Fund, or Vic BlowUpOnceADecadeHoffer with comments on value investing and trendfollowing in interviews and on his blog.
We (all of us, not just value guys) need to realize that, even if we find “A” method that we’re happy with and makes us money, we have not found “THE” method.
Off topic, doesn’t FFH hold a bunch of ORH stock? I thought they did, but memory may be failing me. Isn’t there some double-counting in having both?
You’re make a good point, there are poor attitudes on the otherside as well. I’m just more exposed to the “value elitism”. I’ve seen Victor Niederhoffer criticize value investing for not using enough scientific rigor in one of his later books. He might be better off devoting his attention to his own performance instead of commenting on others.
Re: FFH & ORH
I felt that as a business, ORH was undervalued- esp with the lack of hurricanes and they also held a good CDS position. So I felt that by owning both of them I’d be able to gain leverage.
[...] Ali writes a great post about the follies of our fellow investing clan. I disagree with a few of the specific points he [...]
Your point about complex situations is especially important. As a value investor it is your job to study the hard-to-understand stuff. Chances are something is undervalued in the first place because it is misunderstood. If you don’t put in the effort to find out what folks are missing, I don’t see how you can expect to be successful.