The best value investors consistently outperform the market over prolonged periods of time. However, this does not mean that they will outperform the market every single year. Indeed, there often seems to be a negative correlation between long term and short term success in investing.
In a 2000 presentation entitled "Value Investing and Behavioral Finance," famous value investor Christopher Browne (of the investment firm Tweedy, Browne), explained why this might be the case.
It’s tough being alone
Browne referenced a 1986 study that analyzed the records of seven value investors (cited by Warren Buffett (Trades, Portfolio) as being among the best in the business) over a long period of time. Although all seven outperformed the S&P 500 substantially, none did so every year, and six of the seven suffered annual losses between 28.3% and 42.1%. These huge drawdowns would surely test the mental toughness of even the most committed and emotionally stable investors.
The challenge inherent in dealing with the emotional ups and downs of such a style explains why there are so few real value investors operating in the market. Browne goes on to explain that even many institutional investors - who are supposed to be more sophisticated and long term oriented than the average Joe off the street - are not very good at adhering to long term strategies that produce periods of short term underperformance and favour overpriced "good companies" over undervalued plays.
There are many funds that purport to have an edge (and who charge hefty fees to their clients) that essentially just track the benchmark stock market indices. And while it may be tempting to simply dismiss these firms as "lazy," the more plausible explanation for their unwillingness to deviate from the herd might be that they are afraid of losing business:
“Our own observation [suggests] that institutional clients seem to prefer better companies on the theory that they are more prudent investors. However, in this instance, the prudence may be on the part of the money manager who is more concerned with not losing an account than performing well for his or her client. As far back as the early 1970s, I can remember one of our former partners, Ed Anderson, explaining the herd instinct of professional money managers. If a manager held IBM and it went down, it did not matter because everyone else owned IBM.”
It’s one thing to lose when everyone else around you is losing for the same reasons. It’s quite another to go out on a limb and lose money by investing in a stock that none of your peers think was worth the trouble. Browne’s conclusion was that far too many professional money managers are more concerned with saving face than making money. Adopting a value investing approach all but guarantees that you will occasionally be in the position of the lone loser, which explains why there are so few value investors in the first place.
Disclosure: The author owns no stocks mentioned.
Read more here:
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