Sophocles – Meet The Investor That “Really” Beats The S&P 500 by Tim du Toit, Quant Investing
Did you beat the S&P 500 index over the past four years?
I didn’t, BUT I found someone that has.
Since July 2012 to January 2016 he has managed to give his clients a total return of 113.97% (after all fees) which compares very well to the 52.03% that the S&P 500 (including dividends) returned over the same period.
Luckily he agreed to the following interview.
His name is Sophocles Sophocleous (name pronounced So.fo.clees) and is based in Cyprus, really following Warren Buffett’s advice of not being too close to the investment crowds.
Now on to the interview...
Q&A with Sophocles Sophocleous
How did you get started in investing?
Sophocles: I was fascinated with the financial markets and investing from a young age.
When I was 10 we moved to the island of Cyprus and at the age of 15 I wrote letters to the Wall Street Journal (WSJ), the New York Stock Exchange (NYSE), the Philadelphia Stock Exchange and a few others asking for any information they had.
They were kind enough to send me material. Most of it was way above my head but I enjoyed it all.
I remember first reading about options from the Philadelphia Stock Exchange material and thought how easy I would be able to strike it rich.
I started reading Business Week at the library and told my dad we should buy options on a Hong Kong company.
Of course we didn’t even have a stock broker account, let alone the money. In those days there probably weren’t any options on that company anyway.
Describe your personal investment approach and how it developed over time?
Sophocles: One day in 2011 while I was working for an Emerging Markets high-yield/distressed fund, I started looking at U.S. and other equities and it looked obvious to me that there was an opportunity.
The valuations were cheap and the catalysts were there.
Historically I made some great calls but was too frugal and conservative. As a result I never invested as much as I should have in those opportunities and I was out of the market for long stretches of time.
That is not an optimal approach because even if you make 50-100% but stay out of the market your return could end-up being sub-par.
I finally realized this and decided I needed to change my style.
The big question was how do I not only make a buck but also beat the market.
You already know that most fund managers underperform the market. Most of these guys are pretty smart, so I believe it’s naïve to think that any one of us is smarter than another.
Plus most of them are supported by a team of experienced analysts and expensive tools. How could I do better, as well as outperform the market?
The way I approached the problem was to start fresh by saying to myself, “Assume you know nothing”.
So I started from working from A to Z to find what was the most success approach to investing. From both academic and practitioner evidence we find that value investing produces the highest returns with lower than expected risk.
Most of the papers are all there and available for free to any investor. There is also a whole army of value managers who have become rich and famous with Warren Buffett being the most well-known.
All this was no surprise to me as I had always been a value investor, but the confirmation solidified it.
Describe your investment philosophy?
Sophocles: The problem with value investing today is that many people consider it fashionable or marketable and like to label themselves as value investors.
The crypto-growth guys love to use PEG to put a value spin on an investment. For example, “Yeah it’s got a P/E of 35x but analysts expect 40% growth”.
But what has history and research shown us? That is the basis of my philosophy. I don’t focus on hope but evidence. And evidence shows that analysts’ high growth expectations fail and that the market prices in too much growth.
As human beings it is easy to become emotionally involved and investors find themselves looking for ways to convince themselves to buy or hold on to a stock.
So I needed a philosophy that took care of this problem. During my research I stumbled upon “What Works on Wall Street”. In the book, James O’Shaughnessy shows the results from back testing different statistics and combinations of them.
That inspired me to spend thousands of hours creating and back testing models.
My conclusion was that practically any model that has a value focus will beat the market. This can branch out into a variety of combinations such as value-growth, value-dividends, etc.
So to find investment opportunities I use quantitative value models.
What I like about that is that it solves the problem of emotion. It’s either cheap, as given by the model or it isn’t. There is no middle ground.
Furthermore, you know that the model is based on solid theory and logic and the back tested results provide some emotional comfort.
I use variables that make logical sense and am leery of quantitative machine learning investing. Most of the time, machine learning is a just a sophisticated method of curve fitting that sounds great when you are marketing.
So as you may have understood, while I use investment models, but I do not believe in using them in an automated way.
Obviously we have to correct for data errors, and believe me there are plenty that can occur.
I remember contacting Bloomberg because their output for a $35 billion US listed company gave the wrong number of shares.
But as you know you can’t model everything away. So after generating a list of potential investments, from my model, I conduct qualitative analysis.
I try to understand the story and the reason behind the stock’s cheapness.
Because if a stock is cheap there is always a reason. Most of the time I pass on the opportunity and go on to the next stock on the list.
Every now and again a theme appears.
In 2012 to 2013, it was health care and I got involved in the sector heavily. This was followed by energy but I avoided the sector as I came to the conclusion that oil could fall much further. Now, retail stories are appearing and investors should take notice. Amazon is not going to close every brick & mortar store.
This qualitative analysis has helped improve performance versus running the models in an automated fashion.
What are your ideas concerning portfolio composition and the value of individual holdings in relation to the portfolio?
Sophocles: The problem with the majority of investors is that they ask the wrong question?
Everyone is looking for the next home run.
Each individual stock doesn’t matter; it is the portfolio that matters. You have to be able to