Is value dead?

Francis Chou’s funds have suffered a severe beating lately, but he isn’t calling in the coroners. Now is the time for bargains, says the star value manager, and he insists he knows exactly where they are

Globe Investor Magazine, May 22, 2008
By Rob Carrick
Photographs by Vanessa Heins
Graphs by Douglas Coull/The Globe & Mail
(Source: globeinvestor.com)

In January, Chou left the Bay Street spotlight for budget digs in the suburbs

The cookie-cutter office building stacked amid high-rise condos and streetside retail is not where you’d expect to find the man who oversees $1.2 billion in funds, and who is said to be Canada’s top stock-market bargain hunter. Taped to his door is a plain piece of paper that has been run through a printer: “Chou Associates Management Inc.,” it reads, implying that nothing of much importance is happening here.

The door is locked, but jiggle the handle of the door and out pops Francis Chou, whom I have come to ask about the strange decline in the once-dominant school of value investing. It’s an investing style once described by the late, great value guru Benjamin Graham as the equivalent of rifling through a store’s discount bin. In other words, if you are patient enough to search endlessly and smart enough to know the difference between a true bargain and a bad knockoff, then you can make terrific money.

Warren Buffett, a giant of value investing, has achieved an almost impossible compound average annual return of 21.1% from 1965 through 2007 with his holding company, Berkshire Hathaway Inc. (compared to 10.3% for the S&P 500 Index). Other masters, such as John Templeton and Charles Brandes, have also prospered using this approach, as have Canadian names like Irwin Michael, Peter Cundill, Bob Tattersall and Francis Chou. Until recently, that is. At some point in the past year or two, value investing stopped working. Example: For the 12 months to Feb. 29, three of Chou’s five funds were down 17% or more, as compared with the previous year. Could this be the death of value?

Chou seems faintly tired of reaffirming his faith that cheap stocks always come back up in price. “This is something that happens every six or seven years,” he says. “The stuff that is cheap gets cheaper, and you have no control over it. Eventually, though, the logic prevails if you buy stocks cheap.”

His move from the trappings of Bay Street to this nondescript suburban location several months ago was by no means a retreat from the action. For Chou, it was a decision that meant a shorter commute, and one that squares with his complete lack of affectation. An immigrant to Canada from the town of Allahabad, India, Chou arrived in Canada at age 20. He never attended university, beginning his career as a tool-belt-wearing technician stringing wire for Bell Canada. His career as a money manager unofficially began in 1981 when he formed an investment club with six Bell co-workers and $51,000 in seed money. “I was more ambitious than just being a technician and I was reading a lot, trying to see what I could do,” he recalls. “One day I came across an article in the paper on Benjamin Graham, and then suddenly the light clicked. I felt that was my line.” Chou thinks this may have had something to do with his life as a child in India. “In India, you haggle. And in the stock market, you do the same thing. You’re looking at what something is worth and trying to buy it cheaper.”

Chou read widely to develop his knowledge of investing, and he spent a two-week vacation back in 1982 working as a sort of intern for Bob Tattersall, long-time manager of the Saxon World Growth Fund. Chou’s formative period included a stint as an analyst at the investment firm Gardiner Watson with Prem Watsa, now the chairman and CEO of Fairfax Financial Holdings and a highly respected value investor in his own right.

When I raise the subject of eminent value investors with George Athanassakos, a finance professor who holds the Ben Graham chair of value investing at the University of Western Ontario’s Richard Ivey School of Business, Chou’s name is the first he mentions. Such is Athanassakos’s respect for Chou that he has invited him to lecture to his students a couple of times. “He’s very shy, very nervous,” the professor says of the man Morningstar named as its fund manager of the decade in 2004. “Here you have one of the most successful value investors in Canada, or value investors, period,” says Athanassakos, “and he’s very nervous about talking to people. He calls me every time and says, ‘What do you think I should say?’ I tell him, Francis, you’re the best. Say whatever you want to say.”

Imagine your typical ace mutual fund manager—confident to the point of arrogance, dressed in designer suits and surrounded by office opulence. By comparison, Chou, 52, is quiet-spoken, unfailingly courteous in manner and a modest dresser, if it’s fair to judge by the combination of khaki pants and a sports jacket (they may or may not match) that he’s wearing today. But appearances reveal little about Chou the value investor. His flagship Chou Associates Fund averaged an excellent 12.2% annually from its 1986 inception through Feb. 29 of this year, and its 10-year numbers beat all comers in the global equity category. Chou RRSP, with a core of Canadian content, had a 15-year average annual return of 12.5%.

Still, there’s no question that things did not go well for the Chou group of funds in 2007 and early 2008. Like many other holdings that are managed in the value style, Chou’s funds were hammered to a degree that was out-and-out shocking compared to the performance of the benchmark S&P/TSX composite index. Chou RRSP was down 19.2% for the year to Feb. 29, compared with the previous year, and had an annualized three-year return (if you can call it that) of just 0.83%. The index, by comparison, was off only 0.2% for the same 12 months, and up 11% over the three years. Chou says the strong loonie helped undermine his funds, which have considerable U.S. and global holdings. Generally, though, he says that value investing will underperform 30% to 40% of the time.