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Value investors hit back

RECM’s Piet Viljoen and others explain why they won’t change course.

JOHANNESBURG – As Central Bankers have tried to revive economies after the global financial crisis and easy money chased stocks to new highs, many global value investors have faced trying times.

At home in South Africa, RECM founder and portfolio manager Piet Viljoen, a champion of the value philosophy (buying good quality companies cheaply) has come under fire for underperformance – also on Moneyweb.

Since 1999, when a significant portion of local fund managers considered themselves to be growth investors, there has been a shift in popularity towards value investing, with a large number of firms now citing some kind of value philosophy or bias.

However, not all value investors follow the same process. One potential difference is that some use a benchmark cognisant investment process, which arguably makes them less susceptible to severe underperformance than those – like Viljoen – who construct portfolios from a clean slate.

Different investment styles generally outperform in different conditions, but unlike growth or momentum strategies, the value style may require much longer investment periods for review. This means that there can potentially be long periods of underperformance, which typically lead to fund outflows at the firm and which may put the business under strain.

Is there a risk that value managers will change course when things get tough?

At a Navigate Investment Seminar hosted by Glacier by Sanlam, this question was put to Viljoen and two other global value managers during a panel discussion.

Dylan Ball, vice president, portfolio manager and research analyst at Templeton Global Equity Group, said value as a strategy historically has always come roaring out of the blocks after a bear market hit.

This was the case after the Japanese bubble burst in 1989/1990, in the early 1990s when the US came out of recession and after the dotcom bubble burst in 2000.

But after the market crashed in March 2009, value investing remained out of favour for a number of years.

He said value managers have got to have the discipline and the luxury to maintain their process and philosophy.

“The point at which you want to throw your process away is probably the point at which you are going to make the most money.”

Viljoen said RECM did suffer outflows, but changing their philosophy and process is “the last thing” they would do.

“It is exactly these times when you need to be in value.”

But for investors this can be tough to live with. Viljoen said he can understand why clients are getting out – their neighbours are doing well and the fear of missing out is a very strong human emotion.

He said over time the value strategy works well, but you have to be able to live with periods, which look “pretty hopeless”.

Colin McQueen, global equity portfolio manager at Sanlam FOUR, said he started his career at Phillips and Drew Fund Management in the UK.

The firm is known for not owning any internet stocks in the lead-up to the dotcom bubble. At the time it argued that it couldn’t value it.

McQueen said they didn’t buy a single internet stock and spent two years “standing in the corner” watching “companies with no sales, no earnings and a Powerpoint presentation go through the roof”.

He said the clients who did stay the course, were duly rewarded.

Viljoen also recalled his first job as a fund manager (with Allan Gray) when the firm experienced a period where the value strategy underperformed considerably and its assets under management dropped from roughly R12 billion to R4 billion.

The clients that did stay the course however, had tremendous performance over the next two decades, he said.

In his fund management career spanning almost three decades this has happened four or five times, “and it will happen again”.

McQueen said as a value investor you will typically always be early to buy a stock and almost always early to sell a stock.

He said for them it is important that a company should pass the quality hurdle and diversification within the portfolio is vital – also with regard to the economic drivers.

“History has shown people’s ability to predict the macro economy is much, much worse than their ability to understand an individual business,” he said.

But why only stick to value stocks during times when the strategy does not seem to be working? Why not blend value and momentum stocks?

While some managers do blend different styles, Viljoen said as an investor over time it pays to stick to a way of doing things that you understand and that you are familiar and comfortable with.

The difference between the value and momentum strategies is that value underperforms for long periods of time, but the outperformance is “short and sharp and tremendous”, he argued.

“It [the underperformance] is uncomfortable, most people don’t want to be there.”

He said momentum outperforms most of the time and then underperforms sharply over a short period in which investors lose a lot of money.

Viljoen said if investors are more comfortable or want some momentum they should rather find a good momentum fund manager and put the two portfolios together.

That would make more sense than asking a value investor to incorporate a little momentum, he argued.

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Methinks, the days are over where fund managers can active compete with computer power, connectivity and data ubiquity, brought about by the digital revolution.This is disrupting and dividing the the modes operandi of the so-called, labour intensive fund managers.
The computers continuously create vast value for their investors as a result of the digital revolution. Value managers in my view cannot determine intrinsic value correctly and most of their successes were achieved with stock buying after big bear markets……..

With respect I disagree. Why computers can certainly run trading programs long-term investing requires fortitude and buy in from individuals to with stand long periods of under performance. A computer doesn’t solve human psychology issues.

Sensational headline, some good points, and semantic clarification needed.

We should all be value investors: buying something that provides you expected return and risk.
Value means different things to different people, and fund investors, fund managers, and market participants need to be in synch or aware of where they differ, to find value and realize value.
Piet is 100% right to stick with his philosophy and process. If he doesn’t, the fund investors who share his approach will be let down.
Fund investors need to make sure they understand his approach, and trust it during periods when the environment doesn’t suit it. If not, they must move.
All managers try and position their approach, market their skill, and explain why one should invest with them. Indiscriminate manager bashing or self-promotion is often assisted by not clarifying definitions, benchmarks, and the skill within a process. That is, broad generalization doesn’t help fund investors with their research, to match their capital with a skilled manager sharing the same approach.
Which brings us back to hit back, value, quality, and definitions.
Hit back should read explain, otherwise it moves into marketing rather than education.
Value has to be about buying something cheaper than comparable alternatives. This applies to houses, cars, companies, and funds.
Quality talks to delivering the results you expect. Full stop. In the environment you expect or don’t foresee. Applies to company management or fund management. This is very difficult to deliver, because everyone has different expectations and the future is not predictable (enough).
The market provides the opportunity for active management (consensus underestimated growth or over estimates inertia), and makes a price that is out of line with the fund managers process for valuing companies.
It all comes back to understanding the managers process, assessing the skill, and voting with your money. No fund can suit all investors, and incompatibility of belief doesn’t suit the fund manager or the investor.

Sentiment is in actual fact, the real enemy here, the principles and intricacies of value investing have been usurped by a naive ‘if it looks & sounds like a good company, then it must be one’ mentality, which inevitably is where all the money goes, that has pushed the value guys into a tight corner

Nice article. Difficult to find value in a bull market that has been running for 6 years. Interesting quote: ” “and it will happen again”. Just need to wait for the bear…

”A computer doesn’t solve psychology issues”……I agree with that statement !. The computer is not subject to the ”heard psychology” and will stop and reverse positions like ”long and wrong ”’Sasol shares”, long before the so-called value investor will realise that time decay has set in and that the ”intrinsic value” has declined, despite fundamental analysis that was done!

End of comments.

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