The financial world has changed significantly since value investing was first created. When Benjamin Graham first came up with the concept of investing in a company based on financial fundamentals, it was relatively difficult to get hold of a company’s financial reports, and therefore very few stockholders were investing according to the fundamentals.
Instead, stockholders speculated on price movements. The publication of Benjamin Graham’s two legacy books, "Security Analysis" and "The Intelligent Investor" helped shareholders understand there was more to life than just share price movements and for the next few decades, value investing blossomed. But by the 1970s and 1980s, the financial world had changed so drastically even Warren Buffett (Trades, Portfolio), Graham’s best student, had given up on the traditional form of value investing, instead favoring a high-quality value slant.
Since then it hasn’t become any easier to be a value investor. The wider dissemination of financial information, coupled with the proliferation of financial blogs seeking out deeply discounted stocks, has made it tough to find, research and act on value opportunities before the market re-rates. There are just too many investors chasing the same prize.
The one advantage
The one advantage value investors have left is time arbitrage. Over the past few decades, the average holding period of a stock has slumped. High-frequency traders are to blame for some of these declines, but the shortening attention span of the average investor is also to blame.
Last year Wall Street Journal writer Jason Zweig wrote an article on the average holding period of U.S. investors, drawing on several different sources. One source, analyst Ana Avramovic, a director of trading strategy at Credit Suisse, estimated that the annual turnover rate in U.S. stocks was 307% in 2015, down from a peak rate of 481% in 2009. A turnover rate of 307% indicates an average holding period only 17 weeks.
These figures don’t include exchange traded funds. According to John Bogle, founder of the Vanguard Group, the 20 largest ETFs were traded during 2015 at an average turnover rate of 1,244%, implying an average holding period of 29 days. Morningstar calculates the portfolio turnover at U.S. mutual stock funds is 66%, implying an average holding period of around 19 months, while the New York Stock Exchange estimates its annualized turnover was 63%.
As noted above, some of these figures are skewed by high-frequency traders. The data from mutual funds, however, can be considered a reliable indicator of how jittery portfolio managers have become.
Time arbitrage
This is where time arbitrage comes into play. Value investors can now use time to draw an advantage over the rest the market.
Warren Buffett (Trades, Portfolio) is perhaps best known for his long-term holding periods and low turnover. Investors can learn a lot from this strategy.
A lower turnover means lower costs, less work and lower taxes, all of which are appealing.
Time arbitrage is the ability to invest over longer periods than most other people. Most institutional investors do not have the flexibility to follow this strategy; they are judged on quarterly, monthly or even weekly figures. They cannot afford to hold a losing position for too long, or they lose the confidence of investors. Private investors as well as those institutional investors with permanent capital can take advantage of the rest of the market’s short-term nature.
Being greedy when others are fearful, and fearful when others are greedy, only works if you can hang around long enough for confidence to return or collapse. A large proportion of those managing money are unable to ride out the entire market cycle. Time arbitrage and a long-term investment horizon are the two remaining advantages value investors have over the rest of the market.
Disclosure: The author does not own any stocks mentioned in this article.
