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Fund Manager Q&A

Why Jim O'Shaughnessy still sees hope in the markets Add to ...

With a title like What Works on Wall Street, you would think the fourth edition of Jim O’Shaughnessy’s bestseller, hitting book stores for Christmas 2011, would be the size of a stocking-stuffer this time around.

What’s been working on Wall Street? Not much.

Yet despite the negative real returns on stocks over the previous decade, Mr. O’Shaughnessy not only has come out with a new edition preaching his trust-your-strategy, invest-for-the-long-term mantra, he’s made it bigger: At 681 pages, it’s nearly twice as long as the previous edition in 2005.

All the more space for the quantitative-investing guru – head of Connecticut-based O’Shaughnessy Asset Management and adviser to Royal Bank of Canada’s O’Shaughnessy family of mutual funds – to expand his dense statistical analysis of a wide range of quant strategies, many of which he insists will still bear fruit for patient investors.

In an interview with The Globe and Mail, Mr. O’Shaughnessy shared his thoughts about stock market investing in light of what has transpired in the past few years. Here are some highlights.

On why we should still believe in stocks

“The reason we are so bullish on the next five to 10 to 15 years in the stock market is because of what has happened over the past 10 years. … One of the things you’ll find in the introduction [of the book]is a list of the 50 worst 10-year real rates of return in the U.S. stock market since the 1870s. We take a look what happens one, three, five and 10 years later. When you get to the three-year markets, there are in fact no negative return to stocks following these horrible 10-year periods.”

On how our brains get in the way of sound investing strategies

“The average investor does significantly worse than a simple index … It’s literally because of the way our brains are wired. As [neuro-finance researchers]look at super-fast scans of the brain making decisions under uncertainty, we see that even with a so-called professional investor making the choice, it is not the rational centres of the brain that fire when they’re making those choices. It is the emotional centres of the brain.

“That’s one of the reasons why finding good strategies that have performed well over multiple market cycles – and then having the ability to stick with them through thick and thin, even when they’re not working for you – is the key to good long-term success.”

On why the price-to-sales ratio is no longer his holy grail of value strategies

“In 2008, Ford Motor Co. had the lowest price-to-sales ratio in the S&P 500. I had been a big proponent of the price-to-sales ratio, so if you’d just been listening to me, you’d have said, ‘That’s got to be the stock [to buy]’ It ended up doing very poorly in 2008. When you look at Ford on not just price-to-sales but on a composite of other [value]factors – price to earnings, EBITDA to enterprise value, price to cash flow, shareholder yield [a combination of dividend yield and share buybacks]– it actually didn’t score well at all.

“We’re now telling people that it’s probably better to look at a combination of value factors … Putting them all together and averaging them out, you get a much better return than looking at any one in particular.”

On investors’ current love affair with dividend yields

“If you are an investor who’s retired and hopes to live off the income that your portfolio is generating, then we would focus just on the dividend yield … If you’re an investor who wants a little bit more from the capital-appreciation side of things, but still likes this concept of getting ‘paid by the company,’ then we would tell that investor to pursue shareholder yield. It’s dividend yield plus ‘buyback yield’ – which is [the percentage difference between]how many shares are outstanding now [and]how many shares were outstanding one year ago. We would buy the companies that scored the highest on shareholder yield – with provisions for [having] market cap greater than average [and]value factors better than average. That has proven to be an excellent strategy over time.”



This interview has been edited and condensed for publication.

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