Barry Ritholtz of Masters in Business interviewed Joel Greenblatt (Trades, Portfolio) who runs the Gotham Index Plus Fund (GINDX, Financial) which received 5 stars by Morningstar. He's also the author of a number of investment books like "You Can Be a Stock Market Genius," "The Magic Formula" and "The Big Secret." You can find a full list on his Amazon author page.
Greenblatt ran a hedge fund Gotham Capital which returned 50% per year over a 10 year period before fees. He teaches at Columbia University and genuinely loves the business of investing.
You can listen to the entire 75 minute podcasts here but for my own understanding and your convenience I've summarized the important parts of the conversation between Ritholtz and Greenblatt as well:
How did Greenblatt get involved in investing?
Greenblatt believes his first interest in the craft came through gambling. He and a friend managed to sneak into a dog track in Florida and they were able to place bets. That's where they learned for the first time about having a strategy but still losing because they didn't really know what they were doing.
Later on he got started with Benjamin Graham's net-net strategy which is the foundation of most value investors. It is still practiced by many and Gurufocus even offers a screen for current net-net stocks.
Ritzholtz then comments value strategies have had a pretty rough go. Greenblatt's responds by saying his definition of value investing does not match with the academic definition and how the "factor" is often measured. He doesn't care about stocks at a low price/book or low p/e multiple.
Categorized value investing is not Greenblatt's kind of investing.
It does not bother him that value investing hasn't work for some time. Greenblatt looks at stocks as shares of ownerhsip in a business. If you look at it that way all the academic stuff like Sharpe ratios and Sortino ratios starts looking sort of insane. The whole investment business doesn't make a whole lot of sense if you just invest in businesses.
What was the secret sauce to 50% annualized returns?
There were three things that played a major role:
- They didn't run a lot of money
- Concentrated 90% of the money in 8-10 names
Greenblatt thinks it is weird that when you make private investments in local businesses people think you are being very prudent if you spread it out between 8-10 businesses but if you do the same thing with sotocks they think you are insane.
Gotham Index+ Portfolio
Greenblatt's mutual fund that's basically a 190/90 with 100 going towards the S&P 500 is designed to outperform and profit from his team's analytical work while demonstrating very low volatility and especially muted underperformance towards the S&P 500. He designed the product so it is easy to stick with and people stick with the program. He set it up this way to make sure clients actually capture the outperformance.
The 90/90 part of the portfolio is filled up with their best long ideas and best short ideas. There are a few safeguards to ensure they don't underperform the S&P 500 by too much. For example they keep the 90/90 part to zero beta. Meaning outperformance isn't generated by going long beta. That would bite them on the way down.
Greenblatt think it has actually been a very tough period for his fund because the market just went straight up. The best periods for the fund, relative to the S&P 500 should be when the market is down.
Things have been going up recently that trade at 100x earnings that make very little money or no money at all. It is clear from research it is the absolute worst strategy to invest in that stuff but it's been marching up pretty relentlessly and that hurt them on the downside (I think David Einhorn (Trades, Portfolio) knows what he means).
Greenblatt's team values all the companies in the S&P 500 on a daily basis. Only 16% of the time is it more expensive, 84% of the time the S&P 500 is less expensive. If you go back and look at what returns would be from this level it tends to be in the 3-5% range for the next few years.
How to Be a Stock Market Genius
They talk a little bit about "How to Be a Stock Market Genius," which is a great book. Greenblatt thinks it holds up pretty well. He has his kids read it. That investors don't beat the market is not because a lack of opportunities.
There are plenty of opportunities.
But there are also many, many reasons that cause people to underperform.
Spin-offs are a popular part of the book and Greenblatt says something interesting:
It doesn't matter whether spin-offs outperform. What matters is that they are ripe for mispricing.
When the interview nears its end Ritholtz asks Greenblatt about mentors and favorite books which can be interesting sources of investment knowledge:
Greenblatt's primary mentors have been people who's work he could read:
All of them were helpful to get him interested in investing.
Asked about his favorite books Greenblatt mentions:
Invisible heart by Russ Roberts (basic economics; gave it to his kids)
Moneyball by Michael Lewis (picking stocks is very similar to picking undervalued players)
Power of moments by Heath and Heath
Never split the difference by Chriss Voss
Intelligent Investor by Benjamin Graham (Chapter 8-20)
Buffett Letters by Lawrence Cunningham
Not discussed in the podcast but for your reference, this is what the top 25 long holdings of Greenblatt's GINDX look like: