Ben Inker GMO Q4 letter to investors
Value investing can seem like a pretty easy way to make a living. It almost sounds self-evidently true that our style is the correct one in the long run – after all, how could purchasing undervalued assets not eventually provide superior results? Other investors may make guesses about the future: What will happen to unemployment next year? Will holiday spending grow by 2.3% or 3.2%? Will the new iPad sell 28 million units this quarter? But we can sit back and say none of it really matters because “value will out.” It sounds like such a relaxing way to invest, other than the occasional near-death experience of an investment bubble that won’t stop or an apparent buying opportunity that turns into a value trap.
But the reality is that value investing is trickier to pull off than it seems, and can require those who really want to win to make some difficult trade-offs. These trade-offs can be particularly vexing for those of us who are making their living as asset allocators rather than bottom-up security selectors.
One extremely important issue for value investors is timing. We all know we want to buy assets when they become cheap and sell them as they return to fair value, but how exactly should we do this? If you are building a portfolio out of a relative handful of securities, the simple answer is to move slowly. You simply cannot acquire or dispose of a large position in most securities particularly quickly, so you are forced to move in and out over time. As an asset allocator, this isn’t necessarily true. If we wanted to move $5 billion into the S&P 500 tomorrow, this would not be a problem. Daily volume in S&P 500 futures over the past quarter has been about $140 billion, so we could get $5 billion done over the course of a day without leaving much of a trace. If, however, we wanted to buy $5 billion of Berkshire Hathaway – to pick a large cap stock well-loved by value managers – that would be something like 12 days’ volume, and we’d be well served to build up the position over a period of months, as well as selling over a similar period when investors came to realize that this Buffett guy may know something about investing after all. But just because we can trade something quickly doesn’t mean we should. As a slight spoiler to the rest of the piece, for our asset allocation portfolios we generally try to trade slowly even when we aren’t forced to by liquidity considerations.
The practical upshot of this is that after not selling much equity last year despite the strong rally, we look to be steady sellers of equities this year, and we will very likely continue to sell even if the equity markets fall moderately during the year.