I am a value investor. I hate to give him even more publicity than he already has, but Woodford Patient Capital Trust’s Neil Woodford puts it well: “Valuation,” he says, “is the best form of capital protection.” I wholeheartedly agree.
"It requires you to be a bit dull"
Important risk, is the risk of permanent loss of capital, not volatility which measures temporary losses (and gains) of capital. In markets, what goes down more often than not goes up again: volatility should be thought of as the cost of good long term performance, not a risk to be concerned about (my words, not Woodford’s).
What is important to me is to avoid investing in things that go down, but not up again. In other words, permanent loss of capital. How does one do this? By buying things well below their intrinsic value. In other words, by value investing. Indeed, put like that it’s difficult to understand why anyone would be anything other than a value investor!
In fact, it’s not difficult to understand: being a value investor is hard. It requires you to be contrarian, which human beings are not built for (we like to conform, to be part of a crowd). It requires you to be very analytical and objective, assessing numbers and facts rather than listening to the mass emanation of nonsense. It requires you to accept periods of underperformance: there can be periods of up to 2-3 years when the expensive outperforms. It requires you to be a bit dull – talking about discount to intrinsic value is, let’s face it, not as sexy as talking about the latest fad. But the hard work is all worth it. Funds managed by value investors generally have very good long-term track records.
Now, value investing is most commonly associated with equity investing. But it can also be applied to multi-asset investing.
Take government bonds as an example. Right now, the yield of the 30 year inflation-linked Gilt is -0.9% which means that buying and holding it to maturity will lose you 24% of your real capital. If you measure risk in terms of volatility, be my guest and invest – these things ‘look’ really safe. If you measure risk in terms of potential for permanent loss of capital, step away from the table, leaving the crumbs that may be left on it for someone else.
I seek to apply a value investing ethos to everything I do: tactical asset allocation (the above case of government bonds being a good example), stock selection (where Graham and Dodd began), fund selection (I like managers who themselves have a value investing ethos), and sector/trend research (the value investing articulated by Graham and Dodd was as much about looking for quality and reliability, similar to that which can be found in some long-term trends, as it was about valuation measures).
Published in Investment Letter, May 2015
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.