Joel Greenblatt reveals his two secrets to investment success. He is living proof that active management can still work really well. Greenblatt is Managing Principal and Co-Chief Investment Officer of Gotham Asset Management where he co-manages hedge funds and several hedge fund-like mutual funds utilizing long/short strategies. His behavioral insight that the best investment strategy is one that both makes sense and that you can stick with.
The proposition that active management still works can be made on a case by case basis in the highly competitive stock mutual fund business, but it doesn’t hold up in general. In Greenblatt’s opinion: the investment flows to passive will continue, but there is a silver lining to this trend, which he will explain.
Q4 hedge fund letters, conference, scoops etc
In an exclusive interview, great value investor Joel Greenblatt reveals his two secrets to investment success.
Joel Greenblatt: 2 Secrets To Beating The Market
Transcript
The reason that the wave to pass is really here to stay. I mean whether they'll be some little travels up or down over time big picture. You know I gave a talk at Google a few years ago when I started it this way. You know even Warren Buffett says most people should just index and then I said I agree with him. And then I left no then I said you know but then again Warren Buffett doesn't index and neither do I. How come. And so there's a big dichotomy. If you don't know what you're doing the safest thing to do is to index investing in stocks is really about valuing businesses and try to buy them at a discount. Your other alternative you can't do that. Other alternative is to find a manager who has a good process and sticking with that. But I wrote a book number of years ago I think in 2011 called the big secret. My line is always that it's still a big secret because no one bought that book but in it I talked about the best performing mutual fund for the period 2008 2010 and that fund was up 18 percent a year. But the average investor in that fund market was flat during that decade. So up 18 percent a year was pretty good.
The average investor in that fund managed to lose 11 percent a year on a dollar weighted basis by moving in and out in and out at all the wrong times after the market went up after the market went up people piled in after the fun outperform they piled in after the market went down they piled out or after the fund underperformed. They piled out and turned that 18 percent annual gain into an 11 percent dollar weighted loss and that's just the way people are if you don't know what the manager is doing. You look at past returns but there's been plenty of studies showing the last 1 3 5 years don't have much to do with the next 1 3 5 and really what you're supposed to do is look at process and finding a good manager and assessing that most people don't have that skill set either. I think the good news is that if most people just index. If you're a stock picker and actually do the work there's less competition. Yeah I think that would be helpful as a stock picker long term but the active management business will still continue to be threatened.
You know even if investors understand what the managers doing at least they're investing in a fund and they think they do. But even if they understand that going in they just can't stand it when he underperforms or when a fund underperforms so it's not even Zick. You don't understand the manager in the process it's that psychologically right from behavioral finance point of view. You can't take the pain is that no just the way it is.
Sure, with everyone I mean absolutely. You know the other study I wrote up in the same book was about the best performing institutional funds for the same decade. Looking at the top quartile managers half of them 47 percent spent at least three of those 10 years even though they ended up with the best 10 year record they spent at least three of those years in the bottom decile bottom of bottom 10 percent. So right it's very painful but to beat the market you have to do something different than the market returns are gonna zig zag differently. And even if you're a manager who can stick with your process and that's who ends up winning at the end very hard to get your clients to believe in you after you've had a couple of bad years. Right. It's also hard to keep your job unless you're running your own shop. Right. There is as you mentioned there are problems and there are really agency problems even if you're in a large endowment you know like I said on the board of university endowments. But think of the difficulty of the allocators that that endowment while university is effectively a perpetuity. There's no pension that you have to pay out there's nobody retiring. It's basically a perpetuity should have the longest time horizon of anyone. But there's a gentleman or woman who allocates to U.S. equity managers for private equity managers or bond managers or whatever it is and they're viewed over a three year time horizon it doesn't mean they lose their jobs but they're they'd like to win. They'd like to beat their benchmark over that three year period. And as I always say no one really gets fired but no one throws your parade either if you haven't beat your benchmark. So there's an agency problem even in the funds that should have the longest time horizon. So once again and I view that is good news for stock pickers costs if other people aren't patient. And you can be it's it's it's really a great way to make money. You know I read a great book this past summer or it's called Astro ball. And it was really written by a sports illustrated. You know it's it's sort of next generation Moneyball. But it's all about theU.S. and Astro's and how in 2014 they were the last place they were the worst team in baseball and a sports Illustrated writer wrote a story about them thought to be buried in the magazine.
