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THE VALUE INVESTOR

Joel Greenblatt

New York | Greenblatt is renowned for achieving a hefty 34% annualized gain in his hedge fund from 1985 to 1994, but it was a bumpy ride—most clients couldn't handle the volatility, and he eventually returned their money. For the next decade he managed his personal investments, then he and Robert Goldstein co-founded Gotham Asset Management, which now oversees more than $5 billion (U.S.) in long-short mutual funds and private funds. Greenblatt is the author of the bestseller The Little Book That Beats the Market and has been a longtime professor at Columbia Business School. We spoke to Greenblatt about one of his strategies to beat passive investing and why he's shorting Shake Shack.

Your Gotham Index Plus fund, launched in 2015, combines a passive index strategy with active management. Is it a way to compete with index funds?

I am a believer in active management, but only a minority of active managers can add a lot of value. We think we are one of them. If you are an active manager, you do things differently from the index, and your returns will also zig and zag differently. But investors have a hard time with periods of underperformance. They pile in when the market is up and the fund outperforms, and pile out when the market is down. It's hard for investors to capture the active return that a fund has produced. That's why we put together an indexing strategy using the weights in the S&P 500 index. Then, we add an active overlay to buy the cheapest stocks and short the most expensive. We hope this will fit the bill for many people so they will be able to beat the index without taking on the pain of most active funds.

What do you think of exchange-traded funds that let you bet on everything from cannabis to nanotech?

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Thematic ETFs provide the opportunity to trade in pretty much anything, but most people are not good at it. I am not against them. I am just against most individual investors using them.

What is your outlook for U.S. stocks?

The market is expensive. I am not expecting double-digit returns for large-cap stocks. A more realistic expectation would be 3% to 5% each year for the next couple of years. That's what has happened in the past when the market was at similar valuation levels. Small-cap stocks are even more expensive. The expected return is negative, based on history, at these levels.

Bitcoin has been embraced by some of your value-investor peers. Where do you stand?

Bitcoin is something I can't value. It doesn't have earnings. Using Benjamin Graham's approach to value investing, it's hard to make an informed decision to invest in bitcoin. It's similar, in a way, to gold, but is also an indication of a speculative environment.

Lowe's and Boeing are among your top holdings. What's the attraction?

Amazon is a big competitor for retailers, but Lowe's is insulated because of the size of the things it sells. Many items, including wood, are simply too large and heavy to deliver. Lowe's is gushing cash and gets very large returns on capital. It's also cheaper than Home Depot, which we also own. Boeing, one of a few players in aerospace, has a very good franchise. It, too, gushes a lot of cash, and its stock is cheap relative to competitors. Boeing has many nice attributes, including being a large beneficiary of U.S. government contracts.

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Shake Shack is among your top shorts. Why are you betting against the burger chain?

It's trading at above 60 times pre-tax cash flow. Third-quarter results were not stellar, and it has shrinking same-store sales. Expansion isn't really going to save them because most of the costs are at store level. Most people think they have a long runway to open more stores, but if they are not super-profitable, that is not going to help. Some investors might bid up its stock because they like their burgers, but we think the share price is too hefty. And yes, while I have occasionally been to a Shake Shack, it's the milkshakes I like.

How do you invest your personal money?

Eighty-five percent of my net worth is in the long-short strategies we now manage. About 15% is with managers running private concentrated funds similar to the hedge fund we ran from 1985 to 1994.

What advice would you give to retail investors?

Warren Buffett has said most investors should just index. I agree with him. But Buffett doesn't index, and neither do I. Why? Because there is a great opportunity for active managers who have a disciplined investment process. If you don't know anything about investing, buy the index. If you can find a manager whose process makes sense and you believe in it, you can also make money—and potentially do even better than indexes over time. /Interview by Shirley Won

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