Every year, when Joel Greenblatt (Trades, Portfolio) kicks off his value and special-situation investing class at Columbia Business School, he makes his students a guarantee. "If they are good at valuing businesses, the market will agree with them, typically within two or three years," says Greenblatt, who has been an adjunct professor since 1996.
While he can't make any such guarantees to investors, his track record lends validity to this thesis. Using an über-concentrated deep-value approach, the hedge fund he founded in 1985 produced 34% average annual gains, after fees and expenses, for the first decade. At the end of 1994, Greenblatt and his longtime partner, Rob Goldstein, concluded that their growing asset base would impede future returns because their approach was so narrow. They returned shareholders' money and stopped taking outside investments—though they kept their staff and continued to manage their own capital.
In 2009, at the behest of investors, their Gotham Asset Management firm put out the welcome mat again, this time with a far more diversified approach. The current strategy is, on the surface, pretty simple: Buy more than 300 high-quality names trading at cheap prices, and short more than 300 stocks on the other end of that spectrum. The stock that ranks first on these attributes gets the largest weighting in the portfolio, while the second-best stock gets the No. 2 weighting and so on.
"That's quite a bit different from the six to eight holdings we had once upon a time," says Greenblatt, 56. At the same time the original, highly focused strategy had limited capacity, it also came with extreme volatility. "Rob and I would wake up some days and lose 15% or 20% of our net worth," he adds. "Now it's more like 15 or 20 basis points." (A basis point is 1/100th of a percentage point.)
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