Walter Schloss was one of the great value investors of the last century. His strategy was developed with the help of Benjamin Graham, whom he worked with early in his career. He developed Graham's approach into something that he could work with personally and followed the same principles until his death in 2012.
Over the years he generated tremendous returns for himself and his investors, gains that were so impressive he earned himself a place on Warren Buffett (Trades, Portfolio)'s list of "Super Investors of Graham and Doddsville" (the article published in 1984).
Over the 28 years to the first quarter of 1984, Schloss returned 21.3% per annum for his investors, smashing the annual return of 8.4% churned out by the S&P 500 over the same period.
What is interesting about the way Schloss invested is that he didn't replicate Graham's style exactly. He realized quite early on in his career that Graham's outlook on the market had been shaped by the 1929 depression, an extraordinary environment and one that was unlikely to be repeated. Graham's strategy sought to eliminate the possibility of loss, but at the same time, restricted possible profits.
Here's how Schloss described Graham's risk-averse investment style in an interview with the Outstanding Investor Digest:
"But Graham was concerned with limiting his risk, and he didn't want to lose money. People don't remember what happened before and how things were. And that's one of the mistakes people make in investing as well. In the last 15 years, it's been a remarkable stock market. But people forget what things were like during the 1930s. I think Graham - because he lived through that period - remembered it, was scared it would happen again and did everything he could to avoid it. But in the process of avoiding it, he missed a lot of opportunities. That's one of the problems you always have - you don't really lose, but you don't really make, either. I believe you should remember what took place - even if you weren't around at the time. One of the problems of a lot of the people who went through the Depression - Ben Graham, Jerry Newman and others - is that they keep on thinking that things will always be like that. Even Graham used to say - and quite correctly - that you can't run your investments as if a repeat of 1932 is around the corner. We can have a recession and things can get bad. But you can't plan on that happening. People who did missed this tremendous market. Some people can do it. Most people can't and I don't think they should try."
I think this is an important but overlooked topic. The challenge for traditional value investors is to work on a strategy that offers a blend of both downside protection and upside reward in a bull market. This is not as easy as it sounds. As Schloss said, "Some people can do it. Most people can't, and I don't think they should try."
In the interview, the seasoned value investor went on to say that the one difference between the 1929 market and subsequent bear market is that in the depression, companies went bankrupt. In following markets, bankruptcies have been few and far between, but opportunities to profit have been numerous:
"The only difference was that in 1929, the companies went bankrupt. In 1973-74, the stocks went from $70 to $3. They didn't go bankrupt. They just went way down. And they went down very quickly - not as quickly as October of last year, but very quickly and then up again. I remember Londontown - which manufactured London Fog coats. The darned stock was selling at maybe $12 and went down to $5. It had working capital of $10, so we bought it. And then it went back up - we sold it between $10 and $15. And then Interco took it over at $20."
You could argue investors were faced with the same situation in 2008. There were some bankruptcies, yes, but for the most part, companies recovered and generated impressive returns for investors who were able to buy at the bottom.
Put simply, the investment world has changed significantly since Benjamin Graham first started investing. Investors should have changed with it.
Disclosure: The author owns no share mentioned.
