Josh Friedman is the co-founder of Canyon Partners, a hedge fund invested in a variety of securities and situations, including distressed debt, various arbitrage scenarios and high-yield bonds.
Although these situations are quite removed from the experience of the average retail investor, I like to listen to what guys like Friedman have to say because the principles underpinning their actions typically translate quite well to value investing. At he Fink Investing Conference in May, he discussed several of these ideas.
On the recent underperformance of value investing
It should be of little surprise that value has recently been underperforming growth investing and other such strategies. Friedman thinks this is a temporary state of affairs, however:
“Value investing is always a good strategy, because eventually you will be right. You will be right because the private equity guys who have boundless sums of unused capital will buy those companies because they can sustain high interest payments and a lot of leverage, and therefore get a high rate of return on the equity. Or you’ll be right because some M&A company will say ‘Ah, it’s really antidilutive to buy this company.’ Or you’ll be right because the cash will just show up, because you’re buying cash ultimately.”
On avoiding value traps
Value investing is all well and good, but you have to be sure that what you think is priced as a bargain is not actually a lemon. Friedman discussed a number of industries that are notorious for harboring value traps:
“So you have to be super cautious that you’re not buying companies that are going to be disintermediated by other technologies. A lot of distress over the last decade has been in bad companies with bad balance sheets. In shipping, which has way too many ships because people in certain countries want to keep the shipyards operating. It’s been metals and mining, which is a notoriously corrupt industry which has been hard to invest in.
It’s been in energy, where you’re buying commodity exposure maybe more than anything else. It’s been in retailing - it’s hard to imagine an industry that’s getting more devoured by new technology than retailing, and that then goes into REITs and other things. So it’s hard to buy distressed situations if the size of the pie is shrinking, and you’re buying some buggy whip business.”
I don’t think his point was necessarily that investors should avoid these sectors altogether, just that they should exercise particular caution when getting involved in them. I do think, however, that for someone whose circle of competence does not include these areas, it can be a good heuristic to exclude them simply on the basis that they are, on averagem more dangerous than others. You may miss out on some bargains, but you will probably be happier for it in the long run.
On being overly contrarian
Value investors are by their very nature contrarian. However, it is important to not become excessively bearish and miss out on the good times:
“I think one of the issues that have to be careful with is that when you have really smart people talking about markets, people tend to predict 10 out of the last two recessions. I see this on every endowment board I’ve been on. Every group of smart people sits around and they think about all the bad things that can happen in the market. And they’ll miss 10 years in a row of the market going up, and eventually they’ll be right and they’ll say ‘I told you so.’ And there’ll be an article in the Wall Street Journal saying ‘Isn’t that amazing, the Black Swan has happened.’”
I think a good way to sidestep these issues is to abstain from making market-wide bull or bear calls, and instead to focus on the price of individual securities. Valuing businesses is much easier than predicting the future.
Read more here:
- Howard Marks: This Time It's Different
- Tom Russo: 2 Lessons I Learned From Warren Buffett
- Seth Klarman: Are You Truly Diversified?
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