Difficulty of Outperforming

[StubbleJumper]

Francis Chou has killed the S&P over 15 years, but he hasn't done quite so well over shorter periods...

[undervalued]

I have been thinking about this for a while and I think it is probably better for 99% of the population to use the index, including me. For the past 10 years, I have been unable to beat the S&P index. I did not create 'Alpha' per Howard Mark's Most important thing book.

 

Reasoning behind switching:

1. S&P is efficient way to allocate resources, as a better company emerges, it automatically gets added to the S&P (in essence S&P is the biggest, strongest, best companies in their fields).

2. Individual companies rarely survives, go back 100 years and see how many actually survive today. This proves 'buy and hold does not work' in the long term.

3. Like someone said earlier 90%+ funds failed to beat S&P

 

Anyone in the same boat? What is the best way to switch to S&P from individual stocks? To sell slowly and purchase S&P slowly and over time?

[rohitc99]

I don't think anyone said it was easy to outperform.  I also think that if Horsehead hadn't gone broke this thread likely would not have come up.

 

Why don't you ask Uccmal via private message?

 

That was certainly a catalyst to my thinking about it.  I wasn't picking on him.  It just occurred to me it is really difficult.  Bill Miller performed spectacularly until he didn't and much was lost.  You can find dozens who have crashed badly enough their long term records reverted to the average.  Lampert did great until he met Sears - then he ran into himself and the Peter Principle. 

 

Its awfully hard to recover from a really ugly pick(s).  Walter Schloss kept up high returns for decades by sticking to a tight formula, and never doubling down on anything.  John Neff did the same, with similar results as Walter. 

 

Partly I am tired of my own crappy results the last couple of years.  My portfolio is Now 90% in dividend payers, except pdh, and pwt.  I am trying to pick companies that will maintain, and raise their dividends regularly.  I am willing to take lower total returns to have downside protection.  And I am trying to get them on sale, at least somewhat.

 

there seems to be some link between concentrated portfolios and trouble. most of the spectacular highs and lows seems to be with concentrated portfolios. you keep doing well for some time and then a few bad picks cause the returns to revert to the mean. in contrast the likes of schloss never went for home runs ..so their highs were not as high, but the lows were not as bad.

 

i guess unless one has the skills of a buffett/ munger , a few % outperformance with a diversified portfolio has a much better chance

[turar]

The easiest way to outperform is to buy an index fund. You'll outperform 90%+ of other investors.

 

Even that's not simple though. Vanguard alone offers way more than one. As of January 2016, which index fund should I choose --  S&P or Emerging Markets? And that's just two options.

[randomep]

I have been thinking about this for a while and I think it is probably better for 99% of the population to use the index, including me. For the past 10 years, I have been unable to beat the S&P index. I did not create 'Alpha' per Howard Mark's Most important thing book.

 

Reasoning behind switching:

1. S&P is efficient way to allocate resources, as a better company emerges, it automatically gets added to the S&P (in essence S&P is the biggest, strongest, best companies in their fields).

2. Individual companies rarely survives, go back 100 years and see how many actually survive today. This proves 'buy and hold does not work' in the long term.

3. Like someone said earlier 90%+ funds failed to beat S&P

 

Anyone in the same boat? What is the best way to switch to S&P from individual stocks? To sell slowly and purchase S&P slowly and over time?

 

Well, mr undervalued, maybe you shouldn't be so hard on yourself. You said looking back in hindsight you should've picked the S&P 500, however, what would bring you to do that 15yrs ago. S&P 500 is large cap, but why not the entire world large cap? In that case you would've lagged the S&P 500. Would you say oh it is because you are in US that you want to invest in large caps in your home country?

 

My point is S&P 500 is the most popular but just a select index, nobody knows a priori whether an index will do well either.  By choosing S&P 500 you are choosing 1) large cap and 2 ) US. However, anyone will agree that S&P 500 has had a great run, choosing S&P 500 now is akin to choosing MSFT after its recent great run, over the next 15 yrs S&P 500 may very well underperform other indicies such as US small cap.

 

 

 

[Jurgis]

I have been thinking about this for a while and I think it is probably better for 99% of the population to use the index, including me. For the past 10 years, I have been unable to beat the S&P index. I did not create 'Alpha' per Howard Mark's Most important thing book.

 

Reasoning behind switching:

1. S&P is efficient way to allocate resources, as a better company emerges, it automatically gets added to the S&P (in essence S&P is the biggest, strongest, best companies in their fields).

2. Individual companies rarely survives, go back 100 years and see how many actually survive today. This proves 'buy and hold does not work' in the long term.

3. Like someone said earlier 90%+ funds failed to beat S&P

 

Anyone in the same boat? What is the best way to switch to S&P from individual stocks? To sell slowly and purchase S&P slowly and over time?

 

Somewhat OT.

 

Yes, I am mostly in the same boat. I am thinking what you are thinking (and, no, I'm not an alien who can read your mind :P).

 

However:

 

1. SP500 is expensive right now. It might be really bad time to switch.

2. BRK is really (ok, "rather") cheap right now. Why not switch to BRK? There are other "good" forever hold stocks to switch to that are somewhat cheap right now. But yeah, switching to them relies on their future performance that might not be great.

3. turar is right also: SP500 is not ideal. Of course, you can buy VTSMX ( https://personal.vanguard.com/us/funds/snapshot?FundId=0085&FundIntExt=INT ) or some equivalent. This would resolve the US market coverage. It still does not give you exposure to international markets. If you buy >30% international though, you probably should measure your past performance against that. You may have outperformed 70% US/30% international for last 5+ years, since international has performed really crappily. Not sure about 10 years.

4. If you held cash/bonds, you may need to adjust your performance to account for that percentage of cash/bonds. Don't do it though if you consciously kept that as a "dry powder to buy stocks", not as a "X% in cash/bonds no matter what" allocation.

5. Random thoughts: maybe buying RSP or PRF makes some sense... but who knows.

 

My personal solution so far: I am trying to switch to forever-hold stocks not counting my 2015 excursion into oil land. If we ignore the oil land excursion, I want to see if I can manage to hold the forever-hold stocks. If SP500 crashes, I may switch to it. Not guaranteed though. I wonder if 70%US/30% international would outperform from here. BTW, international indexes suck IMO, so that's another issue.

 

If there is interest perhaps we should start a "Switching from active investing to indexing/delegating/whatever" thread.  8)

[Guest Schwab711]

Hedge Funds:

I'm positive Rennissance meets the 4% hurdle. Don't know why they weren't in the article.

Others I know for sure (as of ~1 year ago):

* D.E. Shaw

* Two Sigma

* some former Citi hedge funds have done well since spin-off

 

Private Equity:

There are lots of public and private P-E firms that have outperformed by 4%. Many factors at work here. I think generalizations like "increased AUM makes outperformance harder" is not necessarily correct (like nearly all generalizations about investing/finance). One year ago, activist investing was all the rage. VRX and PAH blow up and now everyone thinks a large amount of AUM creates a drag. All returns have a story behind them (can be described qualitatively and quantitatively). Of course, anytime you have a qualitative explanation in investing (stock, fund, returns, ect) there are going to be some disagreements as to the accuracy/completeness.

 

Switching to Indexing:

There may be unsustainable reasons the S&P 500 outperformed most indexes (worldwide and by MC size). Large US companies were the first globally to invest in technology, automation, and their tax rate has declined dramatically relative to small/mid-size US companies (or in general, US-only companies). The list goes on.

 

What if the US drops tax treaties with Barbados, Virgin Islands, and so on while simultaneously lowering the US corporate rate? GE is going to take a hit while V/MA's of the world will see a ~11.1% increase in net income! Or, what if the S&P 500 keeps their oil & gas allocation while the industry declines? There is no guarantee the S&P 500 will match the performance of US's "most important" companies over the next 5, 10, or 20 years for any number of reasons.

 

Reasons to learn to invest in individual companies, even if you underperform:

* You learn about accounting and financing (probably will help at work and with your budget at home)

* You spend a great deal of time thinking about how to run a business (this may help you run your own or perform better at work)

* You learn about different industries and read the news more frequently (will probably help you be a more interesting person)

* You learn critical thinking skills

* You learn about markets (will probably help when you buy your car/house/fall-out shelter)

* You are more likely to stay the course (investing in an index is no guarantee that you remain in said index during the bad times)

* The skills above will likely increase your FV employment value by more than your underperformance (I guess this depends on age, too)

* It beats the hell out of chess, bridge, or crossword puzzles for keeping your mind active!

[james22]

For the past 10 years, I have been unable to beat the S&P index.

 

Outperformance over ten-year periods is difficult, sure, but who cares? All that matters is end performance.

 

Remember that the 2000-2002 market loss wiped out the entire total return of the S&P 500 – in excess of Treasury bill returns – all the way back to May 1996. Remember that the 2007-2009 market loss wiped out the entire total return of the S&P 500 – in excess of Treasury bill returns – all the way back to June 1995. Hussman

 

[Jurgis]

For the past 10 years, I have been unable to beat the S&P index.

 

Outperformance over ten-year periods is difficult, sure, but who cares? All that matters is end performance.

 

Remember that the 2000-2002 market loss wiped out the entire total return of the S&P 500 – in excess of Treasury bill returns – all the way back to May 1996. Remember that the 2007-2009 market loss wiped out the entire total return of the S&P 500 – in excess of Treasury bill returns – all the way back to June 1995. Hussman

 

LOL, says the guy who has not made any money for investors for 10 years+ : http://hussmanfunds.com/theFunds.html

 

BTW, his argument is broken: he does not look at market recovery post crashes which produces great returns.

And BTW, there are about 5 people in the world who can avoid market crashes. But of course, there are a lot more who believe they can do so only to be proven wrong.

 

Hussman is a loser who sells to idiots.

[steph]

Strange...every year there is on this board a discussion about last years' performance and every time I am ashamed about my mediocre results. I really thought almost everybody on this board was beating the index by far.  :)

 

1. Investing in an index also has some costs : +/- 0,5%

2. Beating the index even by 2% has a huge imact in the long run

3. Market weighted indexes should be beaten since they are overweighted the most expensive stocks and underweighted the least expensive.

 

Maybe 4% is a high hurdle in the long run for a well diversified fund manager, but I believe there are many fund managers who have beaten the indexes over longer periods.

[Jurgis]

3. Market weighted indexes should be beaten since they are overweighted the most expensive stocks and underweighted the least expensive.

 

This is repeated by every critique of market weighted indexes. But it is not as simple as that. It very much depends where market and economy and investment sentiment is in the cycle. The fact that company X grows revenues/earnings/FCF in excess to others in index does not automatically make it bigger part of the index compared to others. It only happens if its growth is disproportionately rewarded by investors. For contrary example, look at AAPL.

 

Edit: hmm, I just realized that the argument is more complex than I tried to present it. I have to run now, I'll try to come back to it.

[steph]

3. Market weighted indexes should be beaten since they are overweighted the most expensive stocks and underweighted the least expensive.

 

This is repeated by every critique of market weighted indexes. But it is not as simple as that. It very much depends where market and economy and investment sentiment is in the cycle. The fact that company X grows revenues/earnings/FCF in excess to others in index does not automatically make it bigger part of the index compared to others. It only happens if its growth is disproportionately rewarded by investors. For contrary example, look at AAPL.

 

Edit: hmm, I just realized that the argument is more complex than I tried to present it. I have to run now, I'll try to come back to it.

 

This is exactly what I mean. You have more of what the market disproportionately rewards.  You had a lot of energy a couple of years ago and today or when it becomes really cheap you will have none.  You were 50% invested in technology & telecom in 2000. 35% in banks in 2007,.....  . An index investor participates fully in all bubbles.  Apart from the performance there is also the volatility of the index. By avoiding all 'popular themes' in your portfolio you can avoid a lot of the huge market swings and sleep a little bit  better.

 

[frommi]

This is exactly what I mean. You have more of what the market disproportionately rewards.  You had a lot of energy a couple of years ago and today or when it becomes really cheap you will have none.  You were 50% invested in technology & telecom in 2000. 35% in banks in 2007,.....  . An index investor participates fully in all bubbles.  Apart from the performance there is also the volatility of the index. By avoiding all 'popular themes' in your portfolio you can avoid a lot of the huge market swings and sleep a little bit  better.

 

Thats what holds me back of investing in the index now, tech and healthcare make up 35% of the S&P500 at the current point. That is a similar dislocation like in 2000, so going forward its probably easier to beat the market simply by not investing in these two sectors.

[vinod1]

UCCMAL,

 

I was investing in index funds from 2001 to 2005. I was a strong proponent of EMH at that time and spent a lot of time studying various finance topics - EMH, factor models, behavioral finance, historical asset class returns, valuation models, etc.

 

As I studied behavioral finance and watched markets and participants, my faith in EMH weakened.

 

At the same time, the expected returns from markets are looking very low. My estimate at that time was if we are lucky we would get 5% to 7% returns and there is a possibility of lower returns.

 

So I started looking at alternatives to indexing and found Buffett and then Graham. As the financial crisis was starting I sold off the last of my index funds and have been investing on my own in stocks.

 

I mention all this to just highlight that I spent 7-8 years in indexing and another 7-8 years investing directly in stocks so I can sympathize with both approaches.

 

I think indexing makes sense for vast majority of the people. But to the inhabitants of Grahamsville, inoculated with teachings of Graham, value investing is a worthwhile and lucrative approach.

 

Expected returns are again in the 5% to 7% range over the long term for the markets. This is a hurdle value investors are likely to overcome.

 

An equal weight of the largest 10 stocks in S&P 500 returned 20% while the remaining 490 stocks returned around -1% in 2015. We have seen this movie before in 1999. The following three years turned out to be among the best ever for value investors (relative to market) as far as I can remember.   

 

Given the market level and expected returns, given the opportunity set currently available, I think this is a pretty good time for value investing. Anecdotally also, what can be a better time to be a value investor then many value investors are under performing the market and the market is just coming off a 200% return from bottom?

 

Vinod

[Jurgis]

3. Market weighted indexes should be beaten since they are overweighted the most expensive stocks and underweighted the least expensive.

 

This is repeated by every critique of market weighted indexes. But it is not as simple as that. It very much depends where market and economy and investment sentiment is in the cycle. The fact that company X grows revenues/earnings/FCF in excess to others in index does not automatically make it bigger part of the index compared to others. It only happens if its growth is disproportionately rewarded by investors. For contrary example, look at AAPL.

 

Edit: hmm, I just realized that the argument is more complex than I tried to present it. I have to run now, I'll try to come back to it.

 

This is exactly what I mean. You have more of what the market disproportionately rewards.  You had a lot of energy a couple of years ago and today or when it becomes really cheap you will have none.  You were 50% invested in technology & telecom in 2000. 35% in banks in 2007,.....  . An index investor participates fully in all bubbles.  Apart from the performance there is also the volatility of the index. By avoiding all 'popular themes' in your portfolio you can avoid a lot of the huge market swings and sleep a little bit  better.

 

OK, hold your horses. You are just pushing your opinion without really thinking.

 

First of all, we would have to agree what metric you are using to value companies. If you use P/E, then companies without earnings should be 0% of the index to not be "disproportionately" overweighted. I don't think you mean that, so please provide the weight/valuation metric and then we can argue.

 

Popular themes might be bad, but they also might be good. This is not an argument for or against "they are overweighted the most expensive stocks and underweighted the least expensive".

 

You had a lot of energy a couple of years ago and today or when it becomes really cheap you will have none.

 

This is a great example of where your argument is likely wrong - depending on the metric. Let's use PSR as metric since P/E does not work (you can propose something else). So let's say we have 2 company index A with sales 1 and market cap 1 and B with sales 1 and market cap 1. They are perfectly weighted. Now sales of company A drop to .5 (like your energy companies example). So to preserve its weighting it's market cap should also drop to 0.5. Now you probably will complain that B is overweighted, but it isn't.

 

You give examples of bubbles, but that's again hand wavy argument. So, yes, market cap weighted index has bubbles. This does not mean that any alternative that you use won't have similar or worse performance long term. There are two issues with the alternatives:

- They might have the same crashes

- They might not have the same crashes, but may not perform as well during the upcycles.

[Jurgis]

Given the market level and expected returns, given the opportunity set currently available, I think this is a pretty good time for value investing. Anecdotally also, what can be a better time to be a value investor then many value investors are under performing the market and the market is just coming off a 200% return from bottom?

 

Vinod, I respect you a lot, but analogy arguments don't necessarily work. We are not in a huge bubble like we were in 2000 although market is a bit overvalued perhaps.

 

My concern is that the argument is "just continue trying for another year and then another year and then another year". Of course, it all depends on a person. If they believe that past 5 (or whatever) years of underperformance was due to market running up from the bottom and it's going to change now, then perhaps they should keep trying. Although, I am afraid that there is a lot of rationalization. In 2013-2014 it was "index is running up too fast, I can't keep up, all stocks are running up without differentiation". In 2015 it was "index did not run up, but was kept up by FANG, value stocks were slaughtered". At which point should investors face the facts and realize that the issue might be them and not what index did?

 

Anyway, I am not saying that people who have underperformed should jump to index right now. I share some concern that this might be wrong time. But like somebody said keeping doing the same thing and expecting different outcome may indicate foolishness. Or it may indicate strong belief in the method that may be rewarded. Or not. ;)

 

Choose your poison wisely.

 

Peace.

 

 

[Jurgis]

So let's say we have 2 company index A with sales 1 and market cap 1 and B with sales 1 and market cap 1. They are perfectly weighted. Now sales of company A drop to .5 (like your energy companies example). So to preserve its weighting it's market cap should also drop to 0.5. Now you probably will complain that B is overweighted, but it isn't.

 

BTW, here is why the argument "they are overweighted the most expensive stocks and underweighted the least expensive." is very slippery.

In scenario above if A drops to 0.6, the person can point to this and argue "they are overweighted the most expensive stocks and underweighted the least expensive.", since valuation of A is 0.6/0.5=1.2 (compared to valuation 1 of B) and its weight should be 0.5.

But if A drops to 0.4, the person can point to this and argue "they are overweighted the most expensive stocks and underweighted the least expensive.", since valuation of A is 0.4/0.5=0.8 (compared to valuation 1 of B), so B is expensive and overweighted.

 

In some sense the argument is tautology.

[Uccmal]

UCCMAL,

 

I was investing in index funds from 2001 to 2005. I was a strong proponent of EMH at that time and spent a lot of time studying various finance topics - EMH, factor models, behavioral finance, historical asset class returns, valuation models, etc.

 

As I studied behavioral finance and watched markets and participants, my faith in EMH weakened.

 

At the same time, the expected returns from markets are looking very low. My estimate at that time was if we are lucky we would get 5% to 7% returns and there is a possibility of lower returns.

 

So I started looking at alternatives to indexing and found Buffett and then Graham. As the financial crisis was starting I sold off the last of my index funds and have been investing on my own in stocks.

 

I mention all this to just highlight that I spent 7-8 years in indexing and another 7-8 years investing directly in stocks so I can sympathize with both approaches.

 

I think indexing makes sense for vast majority of the people. But to the inhabitants of Grahamsville, inoculated with teachings of Graham, value investing is a worthwhile and lucrative approach.

 

Expected returns are again in the 5% to 7% range over the long term for the markets. This is a hurdle value investors are likely to overcome.

 

An equal weight of the largest 10 stocks in S&P 500 returned 20% while the remaining 490 stocks returned around -1% in 2015. We have seen this movie before in 1999. The following three years turned out to be among the best ever for value investors (relative to market) as far as I can remember.   

 

Given the market level and expected returns, given the opportunity set currently available, I think this is a pretty good time for value investing. Anecdotally also, what can be a better time to be a value investor then many value investors are under performing the market and the market is just coming off a 200% return from bottom?

 

Vinod

 

Vinod, Tx.  I recall reading your notes in conjunction with Security Analysis when I reread it a few years ago. 

 

FWIW, Canada's markets are in a bear, with energy, banks, and services all being hit, energy the worst obviously.  I have no holdings of US companies right now, and moved all of my margin cash over to Cdn. dollars.  I hold SSW but it is not really a US company with its offices in Hong Kong and Vancouver.  So, I am still a value investor.  I didn't even do this on purpose.  The deals in Canada were just better from a Canadian currency perspective.  For example the price for RY, and FN present a more compelling value than BAC, and I will get paid to wait.  Keeping in mind this is from the perspective of a person operating in Canada.  Our dollar will rebound at some point. From a rebounding Cdn dollar perspective a Us stock has an extra 30% hurdle rate. 

 

I have definitely shifted to a "being paid to wait approach".  With that I am accepting lower likelihood of homeruns, but also lower risk. 

 

 

 

 

 

[steph]

3. Market weighted indexes should be beaten since they are overweighted the most expensive stocks and underweighted the least expensive.

 

This is repeated by every critique of market weighted indexes. But it is not as simple as that. It very much depends where market and economy and investment sentiment is in the cycle. The fact that company X grows revenues/earnings/FCF in excess to others in index does not automatically make it bigger part of the index compared to others. It only happens if its growth is disproportionately rewarded by investors. For contrary example, look at AAPL.

 

Edit: hmm, I just realized that the argument is more complex than I tried to present it. I have to run now, I'll try to come back to it.

 

This is exactly what I mean. You have more of what the market disproportionately rewards.  You had a lot of energy a couple of years ago and today or when it becomes really cheap you will have none.  You were 50% invested in technology & telecom in 2000. 35% in banks in 2007,.....  . An index investor participates fully in all bubbles.  Apart from the performance there is also the volatility of the index. By avoiding all 'popular themes' in your portfolio you can avoid a lot of the huge market swings and sleep a little bit  better.

 

OK, hold your horses. You are just pushing your opinion without really thinking.

 

First of all, we would have to agree what metric you are using to value companies. If you use P/E, then companies without earnings should be 0% of the index to not be "disproportionately" overweighted. I don't think you mean that, so please provide the weight/valuation metric and then we can argue.

 

Popular themes might be bad, but they also might be good. This is not an argument for or against "they are overweighted the most expensive stocks and underweighted the least expensive".

 

You had a lot of energy a couple of years ago and today or when it becomes really cheap you will have none.

 

This is a great example of where your argument is likely wrong - depending on the metric. Let's use PSR as metric since P/E does not work (you can propose something else). So let's say we have 2 company index A with sales 1 and market cap 1 and B with sales 1 and market cap 1. They are perfectly weighted. Now sales of company A drop to .5 (like your energy companies example). So to preserve its weighting it's market cap should also drop to 0.5. Now you probably will complain that B is overweighted, but it isn't.

 

You give examples of bubbles, but that's again hand wavy argument. So, yes, market cap weighted index has bubbles. This does not mean that any alternative that you use won't have similar or worse performance long term. There are two issues with the alternatives:

- They might have the same crashes

- They might not have the same crashes, but may not perform as well during the upcycles.

 

 

Hi Jurgis,

 

Probably I am not 'really thinking', but I believe that you think too much.  :)

Even a baby understands that a 'market weighted' index is subject to what the market is willing to value the companies. I don't care about the metric (pe,ps,pb,...), all companies which are highly valued have a high weighting and the more expensive the heavier the weighting and vice versa.

You can argue with a lot of theories but this is just a fact.

[Jurgis]

If you don't want to think and discuss and rather resort to insults, then good luck to you.

[vinod1]

Given the market level and expected returns, given the opportunity set currently available, I think this is a pretty good time for value investing. Anecdotally also, what can be a better time to be a value investor then many value investors are under performing the market and the market is just coming off a 200% return from bottom?

 

Vinod, I respect you a lot, but analogy arguments don't necessarily work. We are not in a huge bubble like we were in 2000 although market is a bit overvalued perhaps.

 

My concern is that the argument is "just continue trying for another year and then another year and then another year". Of course, it all depends on a person. If they believe that past 5 (or whatever) years of underperformance was due to market running up from the bottom and it's going to change now, then perhaps they should keep trying. Although, I am afraid that there is a lot of rationalization. In 2013-2014 it was "index is running up too fast, I can't keep up, all stocks are running up without differentiation". In 2015 it was "index did not run up, but was kept up by FANG, value stocks were slaughtered". At which point should investors face the facts and realize that the issue might be them and not what index did?

 

Anyway, I am not saying that people who have underperformed should jump to index right now. I share some concern that this might be wrong time. But like somebody said keeping doing the same thing and expecting different outcome may indicate foolishness. Or it may indicate strong belief in the method that may be rewarded. Or not. ;)

 

Choose your poison wisely.

 

Peace.

 

Jurgis,

 

I do not disagree one bit with what you have written. Current market is no way comparable to that in 1999 either in terms of overvaluation or dispersion in market values. For most of 2014 and 2015, I thought pretty much everything is closer to fully valued, very little opportunities (at least among the companies I follow) and actively dissuaded some friends from picking stocks and put them in index funds. The market action over the last few weeks, opened up a few opportunities and that I think value investors are likely to benefit from.

 

My comments are more directed towards UCCMAL, who I know is a good investor and who I learned a lot from. I am just trying to point out to him that this might be wrong time to give up on value investing.

 

Vinod

[vinod1]

UCCMAL,

 

I was investing in index funds from 2001 to 2005. I was a strong proponent of EMH at that time and spent a lot of time studying various finance topics - EMH, factor models, behavioral finance, historical asset class returns, valuation models, etc.

 

As I studied behavioral finance and watched markets and participants, my faith in EMH weakened.

 

At the same time, the expected returns from markets are looking very low. My estimate at that time was if we are lucky we would get 5% to 7% returns and there is a possibility of lower returns.

 

So I started looking at alternatives to indexing and found Buffett and then Graham. As the financial crisis was starting I sold off the last of my index funds and have been investing on my own in stocks.

 

I mention all this to just highlight that I spent 7-8 years in indexing and another 7-8 years investing directly in stocks so I can sympathize with both approaches.

 

I think indexing makes sense for vast majority of the people. But to the inhabitants of Grahamsville, inoculated with teachings of Graham, value investing is a worthwhile and lucrative approach.

 

Expected returns are again in the 5% to 7% range over the long term for the markets. This is a hurdle value investors are likely to overcome.

 

An equal weight of the largest 10 stocks in S&P 500 returned 20% while the remaining 490 stocks returned around -1% in 2015. We have seen this movie before in 1999. The following three years turned out to be among the best ever for value investors (relative to market) as far as I can remember.   

 

Given the market level and expected returns, given the opportunity set currently available, I think this is a pretty good time for value investing. Anecdotally also, what can be a better time to be a value investor then many value investors are under performing the market and the market is just coming off a 200% return from bottom?

 

Vinod

 

Vinod, Tx.  I recall reading your notes in conjunction with Security Analysis when I reread it a few years ago. 

 

FWIW, Canada's markets are in a bear, with energy, banks, and services all being hit, energy the worst obviously.  I have no holdings of US companies right now, and moved all of my margin cash over to Cdn. dollars.  I hold SSW but it is not really a US company with its offices in Hong Kong and Vancouver.  So, I am still a value investor.  I didn't even do this on purpose.  The deals in Canada were just better from a Canadian currency perspective.  For example the price for RY, and FN present a more compelling value than BAC, and I will get paid to wait.  Keeping in mind this is from the perspective of a person operating in Canada.  Our dollar will rebound at some point. From a rebounding Cdn dollar perspective a Us stock has an extra 30% hurdle rate. 

 

I have definitely shifted to a "being paid to wait approach".  With that I am accepting lower likelihood of homeruns, but also lower risk.

 

Al,

 

Makes sense. A 30% currency headwind is too big a hurdle to overcome.

 

I too have taken a lower risk approach by eliminating LEAPS almost entirely and moving up the quality curve in companies, the vast majority of which are happen to be decent dividend payers.

 

Vinod

[vinod1]

One more factor to think about when thinking of indexing vs. picking stocks is one's conviction level.

 

For me, I have more conviction (whether in reality that is true or not is an entirely different question) in my ability to assess the earnings of an individual company than in my ability to assess the earnings level of an index. So I find it easier to hold an individual stock in face of severe market losses than an index fund where I have lower confidence.

 

If an index investor does not drink up the kool aid that long term it is going to be ok - I am not talking pejoratively, it is a very effective strategy if you just believe in it - then it does no good to the investor since he is likely to panic and sell at the wrong time.

 

Vinod

[Guest longinvestor]

One more factor to think about when thinking of indexing vs. picking stocks is one's conviction level.

 

For me, I have more conviction (whether in reality that is true or not is an entirely different question) in my ability to assess the earnings of an individual company than in my ability to assess the earnings level of an index. So I find it easier to hold an individual stock in face of severe market losses than an index fund where I have lower confidence.

 

If an index investor does not drink up the kool aid that long term it is going to be ok - I am not talking pejoratively, it is a very effective strategy if you just believe in it - then it does no good to the investor since he is likely to panic and sell at the wrong time.

 

Vinod

...my ability to assess the earnings of an individual company than in my ability to assess the earnings level of an index....

 

+1

 

Indexes or for that matter, stock markets are a concept only. Exist in our collective imagination only. Businesses are arguably  less so, simple to understand businesses even less so, those with powerful franchise value (idiot CEO proof). ...find 20 such at the right price, ha

[original mungerville]

For the past 10 years, I have been unable to beat the S&P index.

 

Outperformance over ten-year periods is difficult, sure, but who cares? All that matters is end performance.

 

Remember that the 2000-2002 market loss wiped out the entire total return of the S&P 500 – in excess of Treasury bill returns – all the way back to May 1996. Remember that the 2007-2009 market loss wiped out the entire total return of the S&P 500 – in excess of Treasury bill returns – all the way back to June 1995. Hussman

 

LOL, says the guy who has not made any money for investors for 10 years+ : http://hussmanfunds.com/theFunds.html

 

BTW, his argument is broken: he does not look at market recovery post crashes which produces great returns.

And BTW, there are about 5 people in the world who can avoid market crashes. But of course, there are a lot more who believe they can do so only to be proven wrong.

 

Hussman is a loser who sells to idiots.

 

No, I don't think Hussman is a loser. He missed the market recovery - he fucked that up big time. Reading his stuff, he doesn't come across as a loser - I haven't seen his results but I bet he hasn't blown up. And if the S&P were to decline to say 1600 or so this year, I would guess (again I haven't tracked his results) - so this is a pure guess, that he would be beating the market since 2000, so for over 16 years. Could that be correct?