Searching for Rational Investors In a Perfect Storm: Value Investing Through 1999-2003

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Searching for Rational Investors In a Perfect Storm: Value Investing Through 1999-2003

By: Greenbackd

Yesterday I covered a 2006 talk, “Journey Into the Whirlwind: Graham-and-Doddsville Revisited,” by Louis Lowenstein*, then a professor at the Columbia Law School, in which he compared the performance of a group of “true-blue, walk-the-walk value investors” and “a group of large cap growth funds”.

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Lowenstein based the talk on an earlier paper he had written “Searching for Rational Investors In a Perfect Storm:”

In October, 1991, there occurred off the coast of Massachusetts a “perfect storm,” a tempest created by a rare coincidence of events. In the late ‘90s, there was another perfect storm, an also rare coincidence of forces which caused huge waves in our financial markets, as the NASDAQ index soared, collapsed, and bounced part way back.

What had happened to the so-called “rational” investors, the smart money, whom economists have for decades said would keep market prices in close touch with the underlying values?Despite the hundreds of papers on markets and their efficiency, it is a remarkable fact that no scholar, not one, has looked to see who are these rational, i.e., value, investors, how they operate, and with what results.

In the paper, Lowenstein decided to see how a group of ten value funds, selected by a knowledgeable manager, performed in the turbulent boom–crash–rebound years of 1999-2003. Did they suffer the permanent loss of capital of so many who invested in the telecom, media and tech stocks? How did their overall performance for the five years compare with the returns on the S&P 500?

To bring a group of rational/value investors out of the closet, I asked Bob Goldfarb, the highly regarded chief executive of the Sequoia Fund, to furnish the names of ten “true-blue” value funds, those which, as they say on the Street, don’t just talk the talk but walk the walk. (Had I prepared the list, I would have included Sequoia, but Goldfarb’s ten is Goldfarb’s ten.) They are all mutual funds, except for Source Capital, a closed-end fund which invests much like a mutual fund. The funds are as follows:

  • Clipper Fund
  • FPA Capital
  • First Eagle Global
  • Mutual Beacon
  • Oak Value
  • Oakmark Select
  • Longleaf Partners
  • Source Capital
  • Legg Mason Value
  • Tweedy Browne American Value

How did they perform?

For most managers, mimicking the index, it was difficult not to own Enron, Oracle and the like, but the ten value funds had stayed far away. Instead, they owned highly selective portfolios, mostly 34 stocks or less, vs. the 160 in the average equity fund. Reflecting their consistent and disciplined approach, they turned their portfolios at one-sixth the rate of the average fund. Bottom line: every one of the ten outperformed the index over the five year period, and as a group they did so by an average of 11% per year, the financial equivalent of back-to-back no-hitters.

The five-year 1999-2003 average annual returns were as follows:

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My name is Tobias Carlisle. I am the founder and managing member of Eyquem Investment Management LLC, and portfolio manager of Eyquem Fund LP. Eyquem Fund LP pursues a deep value, contrarian, Grahamite investment strategy based on the research featured in Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (hardcover, 288 pages, Wiley Finance, December 26, 2012), and discussed on Greenbackd. I have extensive experience in activist investment, company valuation, public company corporate governance, and mergers and acquisitions law. Prior to founding Eyquem, I was an analyst at an activist hedge fund, general counsel of a company listed on the Australian Stock Exchange, and a corporate advisory lawyer. As a lawyer specializing in mergers and acquisitions I have advised on transactions across a variety of industries in the United States, the United Kingdom, China, Australia, Singapore, Bermuda, Papua New Guinea, New Zealand, and Guam, ranging in value from $50 million to $2.5 billion. I am a graduate of the University of Queensland in Australia with degrees in law and business (management). Contact me I can be contacted at greenbackd [at] gmail [dot] com. I welcome all feedback. Connect on LinkedIn, where we’re Friends.