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STRATEGY LAB

Confessions of a former value investor Add to ...

Andrew Hallam is the index investor for Globe Investor’s Strategy Lab. Follow his contributions here and view his model portfolio here.

Despite being an index investor, I have a soft spot for the value methods practised by my Strategy Lab colleague Norm Rothery.

I built a seven-figure personal portfolio by splitting my money in half: One part was always indexed, and the other part was composed of value-oriented stocks. I did well with those stocks, but notice that I’m bald. Value investing is stressful.

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Many investors attempt to dial down the stress by avoiding the ugly, value-priced end of the stock market and investing instead in popular dividend-paying stocks and growth companies. This feels better, especially if you’re buying recent winners. It can also result in solid, respectable returns.

The evidence, though, suggests that neither dividend-hunting nor growth investing is likely to produce spectacular results over the long haul. There is no long list of investment gurus who achieved outsized profits by loading up on popular dividend payers or growth stocks. If an investment hall of fame were to be established, it would be filled with gutsy, contrarian value investors – people like Warren Buffett, Benjamin Graham, Prem Watsa and Bill Ruane.

Given that, why did I eventually decide to ditch value investing in favour of a fully indexed portfolio? For starters, it suited my personality better. I love falling stock markets, so I’m a value bug at the core. But I like the idea of not making mistakes with an individual stock. Today, I prefer to buy them all.

When world markets dive, as they did in 2002 and 2008, I poured money into funds that tracked broad stock market indexes. I didn’t buy them because I was trying to time the market; I bought simply because markets were cheaper than they had been just a few months before.

As an indexer, I don’t care how my money performs over a year, or even over the next decade. This gives me the courage to dive into stock indexes when markets get hammered. If the markets get crushed next month or next year, I’ll do the same with my Strategy Lab portfolio.

Now, granted, a value investor can do somewhat the same thing by diving into the market and looking for individual stocks that he or she thinks are special bargains. The more I see of the markets, however, the more difficult I believe it is for value investors to actually scoop up those hot deals.

Consider Louis Lowenstein’s 2008 book, The Investor’s Dilemma. Hard core value fund managers, Mr. Lowenstein suggests, have great track records of beating the market. To demonstrate his point, he asked legendary value investor Bob Goldfarb of the Sequoia Fund to list the most talented value-oriented investors in the United States.

Each of these investors ran mutual funds—many of which you probably haven’t heard of. But they had crushed the S&P 500 index by more than 11 per cent annually from 1999-2003, and by more than 4 per cent annually from 1995-2005.

You would expect these managers’ funds to be superbly positioned to take advantage of the recent market volatility. Studies suggest, however, that there’s often a degree of randomness to great performance – that strongly performing managers rarely repeat their winning ways.

I wanted to test these funds, so I tracked them from the date that Mr. Lowenstein’s book was published. Did these fund managers take advantage of the market plunge in 2008? And since then, have they beaten the S&P 500?

The answer is no.

Since Jan. 1, 2008, Vanguard’s index fund of the total U.S. stock market has gained 10.54 per cent. And those brilliant value investors? As a group, they gained 9.93 per cent.

Looking at their results, I’m more convinced than ever that I made the right decision to index my money. I only wish I had discovered that before losing my hair.

(Editor's note: An earlier online version of this story misstated the gains of Vanguard's index fund and a group of value-oriented mutual funds. This version has been corrected.)

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Value virtuosos strike out

Since the start of 2008, value investing’s brightest stars have failed to keep up, as a group, with a plain index fund.

Funds

Total investment returns / January 2008-Sept. 28, 2012

Clipper Fund

-10.14%

First Eagle Global Fund

22.0%

FPA Capital

13.6%

Legg Mason Value

-31.2%

Longleaf Partners

-6.1%

Oak Value*

5.7%

Oakmark Select

22.4%

Source Capital

-15.0%

Tweedy Browne American Value

12.7%

Average total return

2.7%

Vanguard Total Stock Mkt. Index

7.7%

* now RS Capital Appreciation Fund. Source: Morningstar.com

 

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