Many know the King of value investing as Warren Buffett. Fewer might be able to name the person who founded it all – Ben Graham.
But very few people, unfortunately, recognize the names that made the methodology great. There are far more value investors than those who appear on the headlines. Warren Buffett named several of them in a speech to business school students – Walter Schloss, Tom Knapp, Bill Ruane, Charlie Munger, Stan Perlmeter, and others.
What’s remarkable about this group is their investment ability. Schloss managed to return of 21.3% annually for 29 years in a period in which the S&P returned only 8.4% per year. Tom Knapp along with partner Ed Anderson returned 20% for 15 years during a period where the S&P500 returned only 7% per year. Stan Perlmeter, a liberal arts graduate with little interest in securities, generated returns of 23% per year against a market that advanced at a compound rate of 7%.
We can continue to go down the list, but I think you get the point: there have been, for a long time, more value-oriented asset managers with ridiculous historic performance than we have given credit to.
A Common Trait in Outperformance
The names above share only one common trait: they were all students of Bill Graham or David Dodd, the grandfathers of value investing. All of the people above took a night class on investing from Graham or Dodd, at some point worked for Graham for his asset management firm, or were introduced to Graham’s philosophy by another member.
In their earliest years as managers of their investment partnerships (in today’s language, a hedge fund) most focused on smaller securities and deviances between the real value of a stock and its price on Wall Street. Buffett himself performed best in his early years, years in which he could exploit the very large discrepancies between price and value in small company stocks, stocks he would later have to abandon because his partnership’s assets grew too large to be of any real value to his fund.
We can broaden the net even further to include all small cap value stocks and compare their returns to large cap growth securities. See the chart below, which shows the massive differences in historical returns for the two investing styles:
So Why Isn’t Value Investing More Popular?
If value investing absolutely destroys every other strategy over the long-run, why haven’t all managers become extreme value investors? Well, there’s good reason – it’s a tough sell.
Asset managers are now judged annually, if not quarterly. These asset managers above would have difficulty attracting investors’ assets today, despite their impressive track records.
Excluding only Warren Buffett, every manager named above underperformed the market in 30-40% of the years he managed capital on behalf of his investors. (Buffett lost to the market in only one year out of 13 years of his partnership’s lifespan.) In fact, Charlie Munger, a man who has worked with Buffett at Berkshire Hathaway for decades, had one of the worst six-year stretches of any asset manager. At one point, his funds had a cumulative deficit in returns of 70%, meaning if you had invested in Munger’s fund during this period, the S&P would have outperformed your investment by 70%.
By the time Munger closed the fund, however, his partners earned a return of 32.9% annually over a period of 19 years, compared to the total S&P500 return of 7.8%.
When Marketing Meets Investing
Marketing is just as much a driver of fund flows as is historical performance. Any financial advisor would face scrutiny – if not the eventual closure of his or her business – if he were to recommend a fund to investors that, for a six-year period, lagged its benchmark by 70%. Of course, over the complete 19 year period, investors would have been elated by the fund manager’s performance.
Despite the track record of the value style, it is the ups and downs that will keep it as unpopular as it is. Value investing is a very different strategy than fund investors could ever reasonably employ. It does not require indexing, and the managers using the style care very little about relative returns to a benchmark.
Thus, the stocks in a value fund are often very different from a typical mutual fund. Naturally, value investors show the largest deviance between their returns and that of the broad market in the short-term. In the long-term, however, the deviance is entirely positive – the track record, as well as the chart above, does not lie.