As I was reading through one of Warren Buffett (Trades, Portfolio)'s letters to his partners from 1964, he discusses if his investment methods can be regarded as conservative, provided the outperformance to the Dow Jones index and other mutual funds. His answer provides great insight on the value investing mindset.
"In looking at the table of investment company performance, the question might be asked: “Yes, but aren't those companies run more conservatively than the Partnership?" If you asked that question of the investment company managements, they, in absolute honesty, would say they were more conservative. If you asked the first hundred security analysts you met, I am sure that a very large majority of them also would answer for the investment companies. I would disagree. I have over 90% of my net worth in BPL, and most of my family have percentages in that area, but of course, that only demonstrates the sincerity of my view - not the validity of it.
It is unquestionably true that the investment companies have their money more conventionally invested than we do. To many people conventionality is indistinguishable from conservatism. In my view, this represents erroneous thinking. Neither a conventional nor an unconventional approach, per se, is conservative. Truly conservative actions arise from intelligent hypotheses, correct facts and sound reasoning. These qualities may lead to conventional acts, but there have been many times when they have led to unorthodoxy. In some corner of the world they are probably still holding regular meetings of the Flat Earth Society.
We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don't. A public opinion poll is no substitute for thought. When we really sit back with a smile on our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course of action obvious. In that case - whether other conventional or unconventional - whether others agree or disagree - we feel - we are progressing in a conservative manner."
The main takeaways from these comments are the following:
Conventionality is not the same as conservatism. Buffett provides a very profound point that can be complemented by what Howard Marks (Trades, Portfolio) mentioned in one of his memos. To achieve alpha, an investor must not only think different, but also be right in that different thinking. Those different thoughts can only improve their chances to be right by intelligent hypotheses, correct facts and most importantly, sound reasoning. As Buffett comments, there will be times where this process will lead us to invest in conventional ways, but most of the time, it will lead the true value investor to step away from the crowd. Only by being right can one reap profits of thinking differently.
Public poll is no substitute for thought. The opinion of the crowd should be irrelevant to the value investor. Sure, sometimes it will coincide and others it won't, but that is not what creates value. What creates value is placing bets on deals we can understand, appraise and that provide us a margin of safety. This is the only way to truly invest in a conservative manner.
What do you think?
