Volatility, they say, is a friend of value investors. But the crisis of 2008 proved to be an exception to the rule. Take the case of Charles Brandes, the 70-year-old founder of Brandes Investment Partners, who saw assets under management wilt from an eye-popping $111 billion at the end of 2007 to around $21 billion in a span of five years. But the turn of events has not shaken the confidence of the dyed-in-the-wool value investor, who believes that so long as human nature doesn’t change, value investing will remain an effective long-term investment strategy. Incidentally, Brandes is among the privileged few to have legendary value investor, Benjamin Graham, as a mentor. Their relationship began in 1972 when Graham walked into a brokerage where Brandes worked, wanting to buy a stock. Those initial learnings from Graham have since become the foundation of Brandes’ investment philosophy for the past 39 years. Among the very first to have started investing in emerging markets way back in 1982, Brandes believes that while volatility can distort prices in the near term, the value of a business is eventually reflected in stock prices over the long term.
Tell us about how you got to meet value investing doyen Benjamin Graham.
I was very interested in economics and had embarked on an investment career in 1968. The late 1960s was a go-go era with a lot of hot new initial public offers (IPOs). The onset of the bear market in 1970 wiped out all these new concepts and the market was down 40-45%. One couldn’t have had a more stomach churning initiation. I didn’t know what to do as I didn’t have any guidance or an investing philosophy. I was still looking around and one day Benjamin Graham walked into the brokerage office, where I was working, to buy National Presto Industries. And since I was the designated person to greet incoming people, I got to interact with him. Soon after, when I paid a visit to his office, he kept asking me a lot of questions for which he already had the answers. For me, as a rookie, it was unbelievable that I was being asked questions to guide Benjamin Graham! I did have a few opinions even at that time, though.
Had you read any of his books before you met Graham for the first time?
I had read Security Analysis but not The Intelligent Investor. But after meeting Graham, of course I read The Intelligent Investor very carefully and got to know the story about Warren Buffett reading the same book and the pivotal effect it had on him. I think Buffett read it in 1949 and I read it 22 years later in 1971. To be able to interact, talk and then re-read his concepts helped me realise that it was magical, and that’s how I got attracted to value investing. When I started my investing career, value investing was called Graham & Doddism. The term value investing has come about much more recently.
You went ahead and invested in emerging markets (EMs) much ahead of others…
When I started my firm in 1974, I was not just fascinated by the US market but also with the potential investment and knowledge of other markets. But there weren’t a whole lot of public companies in EMs to invest in and hardly any reports or disclosures. The closest EM to San Diego, where my office was located, was Mexico. At that time, Mexico would have been called a frontier market, not an emerging market. In 1982, the Mexican government faced a debt crisis. As value guys, we thought that, perhaps during a crisis like this, we can get an opportunity to invest cheap. Going through the S&P 500 book, I found state-owned Telefonos de Mexico. The only reports I could get was some old balance sheets and income statement for two years. But just looking at those I said, “Wow, look at the price. It looks like the stock is trading at 10% of the book value.” Of course, you can’t believe the book value and it looked like it was trading at 1X or 2X reported earnings. That was the first EM in which we invested. From then on, over the years we have continued to invest in EMs, depending upon the opportunities that arose.
When you invest in EMs, is there an optimum level of diversification that you seek? And when you diversify, is it more to eliminate risk or volatility?
We do not seek optimal diversification in portfolios but seek optimal long-term investment opportunity, with a satisfactory level of diversification. If you look at recent statistics, EM volatility has been going down compared with some developed markets. I think that is going to be case in the future as well. I don’t think that we will have the events in EMs that we have had in the past. When you are thinking about volatility in EMs, you are thinking more about past considerations than what will happen in the future. I wouldn’t be the least bit surprised if volatility in EMs becomes very much like that in developed markets — the old globalisation thing. Also, if you look at the Asian financial crisis in 1997 and 1998, the South American debt crisis such as the Argentinean debt crisis in 2001 and 2002, or the Mexican debt crisis in 1982, and now the European debt crisis — all are related to government debt. However, today, the balance sheets of most EM economies are strong and even stronger are balance sheets of companies in the private sector. That’s sufficient vindication that EMs are unlikely to be volatile.