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Imagine that, back in January, you were given an ironclad forecast of how the world and economy would shape up in the first half of 2014.

You would have known in advance that the U.S. GDP would have a negative print for the first quarter, that Ukraine would explode into violence with Russian involvement — and that the much-touted housing recovery would begin to show signs of slowing down.

You would have known that Iraq would see sectarian violence, and that Islamists separatists would successfully attack major cities and seriously destabilize the region. You would have had information showing you that the prices of important food items like coffee, hogs and cattle would experience double-digit price surges.

You would have foreseen the strict, new environmental regulations imposed on industry and utilities. The slowdown in retail profits and decline in consumer confidence would have been no surprise to you, because you would already be in the know about these things.

Good Information Isn’t Always Enough

Now, given the fact that the economy never really picks up any steam, the global geopolitical situation is worsening dramatically, food and energy prices are up and the jobs situation is still lukewarm at best, how would you have placed your bets on the direction of the stock market?

A rational person would have bet against higher prices and sold the market short. And they would have been wrong, as stock prices have hit new highs so far this year. Unless you had the foresight to realize that zero rates really do trump all in today’s world, the combination of factors would have made you very skeptical of any likelihood of a stock market advance.

Even with perfect information you could not have predicted how the stock market would react to various events, and most of us would have bet on the wrong side of the trade.

Predicting the stock market is a futile exercise for most investors. If the markets were rational it might be possible, but the simple truth is that they are not. Human psychology plays as big a role in market behavior, as economic numbers and corporate profits do in the short to intermediate term. The stock market tends to overshoot on the side of both fear and greed, and is rarely priced to accurately reflect current conditions.

Look at What Is Undervalued

Guessing what will happen and them how the market will react is a waste of time, and more importantly a waste of money the vast majority of the time.

Research and reality has shown that investors can gain a huge edge on the market by focusing their attention on corporate valuations and adopting a longer time frame. Rather than worrying about and betting on what the market might do in the future, most investor’s time would be better spent looking for stocks and even sectors that are undervalued and have the potential for enormous long term price recovery.

Ironically, adopting this approach would force investors to be buying after large declines and selling rallies, rather than the well-documented tendency to buy exciting markets as they approach the top and selling scary ones as they begin the bottoming process.

Get Rich Quick Doesn’t Happen

It seems that everyone wants to be the next George Soros or Ray Dalio; making grand, spectacular bets on equities bonds and currencies. They want to be in the center of the action, trading in and out of the market and racking up spectacular profits. Everyone is selling some “get rich and quit your job, day-trading from home” program — and they sell pretty well, apparently.

The sad truth is most people who try these trading programs are not going to get rich and will probably lose a good deal of money. The reality is that, like great baseball players, for every one that goes on to hit those game-winning home runs and make spectacular catches, there are 99 who didn’t make it. We can hope and dream all we want, but most people who try to make a living by guessing market direction will fail.

Instead of trying to emulate Jesse Livermore and Paul Tudor Jones investors should aspire to be the next Leon Black or David Rubenstein. These two private equity investors have made a fortune buying undervalued companies and assets, holding them for an extended period of time and then selling them at a profit. Rather than search for penny stock profits they should try to act like Seth Klarman, who has compiled a fortune by acting as the buyer of last resort in falling markets, and insisting that every dollar invested has a large margin of safety.

There is an enormous amount of money to be made in the market. However, it is probably not going to come from guessing market direction and furious trading. The real money, especially for individuals, is in reacting to what the market does and buying when stocks are cheap and selling them when they are not.

Cheap assets and long time frames are a much more reliable path to big profits than the seemingly more exciting trading and guessing approach to investing. The industry continues to present opportunities for value-investors who can weed through the daily noise of the market. Learn about Banking’s Top “Insider Secret,” known as the Great Bank Reduction.

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We’ve added 3 New Speakers to the 10th Annual New York Value Investing Congress!

  • Guy Spier manages the Aquamarine Fund  in Zurich and made headlines by bidding $650,100 with Mohnish Pabrai for a charity lunch with Warren Buffett. He recently authored  the critically acclaimed The Education of a Value Investor.
  • Andrew Left is Executive Editor of Citron Research. He has the longest published and most highly predictive track record of any market commentator or columnist on the specific topic of fraudulent and over-hyped stocks.
  • Adam Crocker is co-manager of Metropolitan Capital Advisors with CNBC’s Karen Finerman. Metropolitan is a  value-oriented hedge fund founded in 1992.

We are now offering  a special discount – over 50% off! — on registrations for the NY Congress taking place September 8 & 9, 2014.  This year, seating will be strictly limited to 275, so we would encourage Greenbackd readers to register now, before we sell out.

Regular Price: $5,995 Special Offer – Over 50% off untill offer expires: 7/15/14

Discount Code: GREENBACKD

URL:  http://www.valueinvestingcongress.com/congress/register-now-partners/

Below please find information about the event:

10th Annual New York Value Investing Congress

  • Date:  September 8 – 9, 2014

Confirmed speakers include:

  • Leon Cooperman, Omega Advisors
  • Alexander Roepers, Atlantic Investment Management
  • Carson Block, Muddy Waters Research
  • Whitney Tilson, Kase Capital
  • Sahm Adrangi, Kerrisdale Capital Management
  • David Hurwitz, SC Fundamental
  • Jeffrey Smith, Starboard Value
  • Michael Kao, Akanthos Capital Management
  • Guy Gottfried, Rational Investment Group
  • John Lewis, Osmium Partners
  • Tim Eriksen, Eriksen Capital Management
  • Cliff Remily, Northwest Priority Capital
  • With many more to come!

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Greenbackd and Eyquem Investment Management are proud supporters of the Capitalize for Kids Investors Conference.

Capitalize for Kids brings the investment community together at an annual event centered around great investment ideas and in doing so, provides support for the Hospital for Sick Children. Sophisticated investors will converge to meet, share ideas, and learn from some of the world’s most successful money managers, many of whom rarely share their ideas publicly.

This year’s speakers include Larry Robbins, founder of Glenview Capital Management; Jamie Dinan, founder and CEO of York Capital Management; Jacob Doft, Jeffrey Smith CEO and CIO at Starboard Value; Sahm Adrangi Managing Partner, Kerrisdale Capital Management; Steven Shapiro, founding partner of GoldenTree; and more than a dozen other world class institutional investors ready to share actionable ideas with attendees and detail their approach to analyzing potential investments.

Where:

Arcadian Court
401 Bay Street, Simpson Tower, 8th Floor
Toronto, ON M5H 2Y4

When:

October 23 – 24th, 2014

Fees:

Single Seat: $2,500
Table of 10 Seats: $25,000

Contact Information:

Register Today for Capitalize for Kids Investors Conference

Our Speakers 

  • Lee Ainslie III of Maverick Capital
  • Steve Shapiro of GoldenTree Asset Management
  • Marc Lasry of Avenue Capital
  • Larry Robbins of Glenview Capital Management
  • Jody LaNasa of Serengeti Asset Management
  • Jamie Dinan of York Capital
  • Jacob Doft of Highline Capital Management
  • Michael Thompson of BHR Capital
  • Brian Zied of Charter Bridge Capital
  • Jeffrey Smith of Starboard Value
  • Evan Vanderveer of Vanshap Capital
  • Frank Brosens of Taconic Capital
  • Jeff Hales of Alignvest Capital
  • Scott Ferguson of Sachem Head Capital Management
  • Chuck Akre of Akre Capital
  • Guy Gottfried of Rational Capital
  • Sahm Adrangi of Kerrisdale Capital
  • John Thiessen of Vertex One

What Are We Supporting?

We are committed to raising funds in support of the highest priority needs of the Centre for Brain and Mental Health. An investment in one of the key funding priorities listed below will help ensure that SickKids remains at the forefront of brain health research, learning, and care for the benefit of children everywhere:

  • Seed Funding Grant Competition
  • Integrative Fellowships
  • Knowledge Translation Program
  • Neonatal Intensive Care Unit (NICU) MRI Scanner
  • Epilepsy Classroom

Register for Capitalize for Kids Investors Conference

capitalize-for-kids-investors-conference-page-001

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Cliff Asness, founder of AQR, seems to be doing the rounds lately. Forbes has a great interview with him called Efficient Market? Baloney, Says Famed Value And Momentum Strategist Cliff Asness.

Here’s Asness talking about the outperformance of value:

Forbes: Isn’t it all about probabilities? You can’t predict the future, but do you feel you can find patterns that generally hold up?

Asness: It’s all about probabilities. And I love that you put it that way. I don’t think it’s different necessarily for non-quantitative firms. We just might acknowledge it a little more explicitly. But I’m in a business where if 52% of the day I’m right, I’m doing pretty well over the long term. That’s not so easy to live with on a daily basis. I like to say, when I say a strategy works, I kind of mean six or seven out of 10 years. A little more than half the days. If your car worked like this you’d fire your mechanic. But we are playing the odds. Some famous findings, cheap stocks, defined simply, price-to-book, cash flow, sales.

You can try to do better, but define it simply. Beat expensive stocks. They beat them on average with a small margin and you want to own a ton of them and be underweight or short a ton of the expensive ones because something like this for one stock means almost nothing.

On active versus passive investment, and the central paradox of efficient markets:

Forbes: How do you defend your approach? Not in the specifics, but the whole thing on indexing. We all know Malkiel and others, Charlie Ellis, will tell you that if you have the discipline to stick to an index, low fees. Your fees are relatively high. Wouldn’t you just be better off saving all that brain power and just riding the wave?

Asness: Sure. Off the bat I’ll tell you my two investing heroes, and there are a lot of good ones to choose from, are Jack Bogle and my dissertation advisor, Gene Fama. So I can’t sit here and put down indexing too much. And in fact when I’m asked, “What advice would you give individuals who are not going to dedicate themselves to this and what not,” I tell them, “The market might not be perfectly efficient, but for most people acting as if it is,” and this is not the only way to get to an index fund, but it’s one route to get to it, it’s certainly one route that implies an index fund. I tell them to do that.

Having said that, there are a lot of ways to get here, but there’s a central paradox to efficient markets. Efficient markets says you can’t beat an index, the price contains all the information. For a long time we’ve known, academics have known, that somebody has to be gathering that information. The old conundrum: What if everyone indexed? Prices would be wildly inefficient.

So I do take what ends up being an arrogant view, and I admit it, that on average people don’t beat the index. Here are the mistakes they make. Here are the risk premiums you can pick up. I do think it’s somewhat profitable, and we want to be some of the people helping make the markets efficient and we think you get paid for that. So that is both how I reconcile it and how I sleep at night.

But if an individual came to me and said, “What should I do?” I don’t say, “Pour your money into my fund,” because, for one thing, they don’t know that much and if we have a bad year they won’t stick with it. I tell them, “Study the history a little bit, just a little bit, and put it in the most aggressive mix of stocks and bonds that you wouldn’t have thrown up and left in the past. And go to Jack Bogle to get it.”

On quantitative value as practiced by AQR:

Forbes: Quickly go over what you call the four styles of investing, starting with value.

Asness: …

And that’s kind of the holy grail of investing. To find various investments, of course, and I know you know this, that go up over time — there’s no substitute for going up — but that go up at different times.

To us, the academic literature has produced a ton. If you want to be a cynic, they’ve produced too many. A lot of smart people with even smarter computers will turn out a lot of past results and we have hundreds of different effects. The blank effect. The silliest ones are things like the Super Bowl, the sunspot effect.

But when someone searches every piece of data and it’s not that silly, it involves an accounting variable, even if ultimately it’s silly when you drill down, it’s harder to dismiss. What we did was kind of almost a self examination of going through and saying, “Of all these things we’ve been reading about for years, many of which we’ve been implementing, if we had to bet the ranch,” now we’re quant, so we never bet the single ranch on anything but over the long-term, if we had to really say, “What are the biggies that we would be most confident in?” They have to have worked for the long term. Data still counts. They need to have great intuition. They have to have worked out of sample, that thing I was talking about before, after they’ve been discovered. If they were discovered in 1970, how’d they do after that? A telltale sign of something that was dredged out of the data is discovered in 1970. Wonderful for the first 70 years of the century and terrible for the last 30 years.

And it has to be implementable. Meaning, there are some things that academics and others look at that when you try with real world transactions cost in a real world portfolio, you find, “Gee, gross, I made a lot of money but net Wall Street made a lot of money. I didn’t make a lot of money.”

Came down to four. Value. Cheap beats expensive. Famous is in U.S. stocks. For me it’s very related to Graham and Dodd value. It’s the same intuition. But where most Graham and Dodd investors will use it to pick a handful of stocks we’ll say the thousand cheapest on our favorite measures will beat the thousand most expensive. We’re betting on a concept more than a specific firm, but looking for the same ideas.

I still think of value as the hero of the story. You’re a manager long cheap and short expensive. I’m the momentum heretic. I’m long good momentum, short bad momentum. A good year for you is usually not my best year. Think about it. It works in the math but also in spirit. When value’s being rewarded you would not think it’s a particularly good time for momentum.

If there’s any magic to the finding, and I’m still amazed by it, is while we hedge each other a bit, more than a bit, both of us make money if we follow it with discipline over time.

Read Forbes’ Efficient Market? Baloney, Says Famed Value And Momentum Strategist Cliff Asness.

Click here to read earlier articles on Asness, AQR’s Value Strategies In Practice or On The Great Shiller PE Controversy: Are Cyclically-Adjusted Earnings Below The Long-Term Trend?.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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Institutional Investor has a great piece from Clifford Asness and John Liew called The Great Divide over Market Efficiency on the efficient markets debate. Most interesting for me was their discussion on the launch of AQR and the “value” strategies it employs:

Starting in the mid-1980s, researchers began investigating simple value strategies. That’s not to say value investing was invented at that time. We fear the ghosts of Benjamin Graham and David Dodd too much to ever imply that. This was when researchers began formal, modern academic studies of these ideas. What they found was that Graham and Dodd had been on to something. Stocks with lower price multiples tended to produce higher average returns than stocks with higher price multiples. As a result, the simplest diversified value strategies seemed to work. Importantly, they worked after accounting for the effects of CAPM (that is, for the same beta, cheaper stocks still seemed to have higher expected returns than more expensive stocks). The statistical evidence was strong and clearly rejected the joint hypothesis of market efficiency and CAPM.

We started our careers in the early 1990s, when as a young team in the asset management group at Goldman, Sachs & Co. we were asked to develop a set of quantitative trading models. Why they let a small group of 20-somethings trade these things we’ll never know, but we’re thankful that they did. Being newly minted University of Chicago Ph.D.s and students of Gene Fama and Ken French, the natural thing for us to do was develop models in which one of the key inputs was value. …

Asness Long Short Value v2

Above is a graph of the cumulative returns to something called HML (a creation of Fama and French’s). HML stands for “high minus low.” It’s a trading strategy that goes long a diversified portfolio of cheap U.S. stocks (as measured by their high book-to-price ratios) and goes short a portfolio of expensive U.S. stocks (measured by their low book-to-price ratios). The work of Fama and French shows that cheap stocks tend to outperform expensive stocks and therefore that HML produces positive returns over time (again, completely unexplained by the venerable CAPM). The graph above shows this over about 85 years.

If you notice the circled part, that’s when we started our careers. Standing at that time (before the big dip you see rather prominently), we found both the intuition and the 65 years of data behind this strategy pretty convincing. Obviously, it wasn’t perfect, but if you were a long-term investor, here was a simple strategy that produced positive average returns that weren’t correlated to the stock market. Who wouldn’t want some of this in their portfolio?

Fortunately for us, the first few years of our live experience with HML’s performance were decent, and that helped us establish a nice track record managing both Goldman’s proprietary capital, which we began with, and the capital of some of our early outside investors. This start also laid the groundwork for us to team up with a fellow Goldman colleague, David Kabiller, and set up our firm, AQR Capital Management.

As fate would have it, we launched our first AQR fund in August 1998. You may remember that as an uneventful little month containing the Russian debt crisis, a huge stock market drop and the beginning of the rapid end of hedge fund firm Long-Term Capital Management. It turned out that those really weren’t problems for us (that month we did fine; we truly were fully hedged long-short, which saved our bacon), but when this scary episode was over, the tech bubble began to inflate.

We were long cheap stocks and short expensive stocks, right in front of the worst period for value strategies since the Great Depression. Imagine a brand-new business getting that kind of result right from the get-go. Not long cheap stocks alone, which simply languished, but long cheap and short expensive! We remember a lot of long-only value managers whining at the time that they weren’t making money while all the crazy stocks soared. They didn’t know how easy they had it. At the nadir of our performance, a typical comment from our clients after hearing our case was something along the lines of “I hear what you guys are saying, and I agree: These prices seem crazy. But you guys have to understand, I report to a board, and if this keeps going on, it doesn’t matter what I think, I’m going to have to fire you.” Fortunately for us, value strategies turned around, but few know the limits of arbitrage like we do (there are some who are probably tied with us).

On the question of market efficiency, years as practitioners have put Asness and Liew somewhere between Fama and Shiller:

We usually end up thinking the market is more efficient than do Shiller and most practitioners — especially, active stock pickers, whose livelihoods depend on a strong belief in inefficiency. As novelist Upton Sinclair, presumably not a fan of efficient markets, said, “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!” However, we also likely think the market is less efficient than does Fama.

After backtesting countless “value” and fundamental strategies for our book Quantitative Value I found myself in the same boat. There exist some strategies that, over the long term, lead to a consistent, small margin over market, but fewer work than most believe, and our own efforts to cherry pick the model inevitably lead to underperformance.

Click here to read The Great Divide over Market Efficiency and here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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MoI Cover

John Mihaljevic’s The Manual of Ideas: The Proven Framework For Finding The Best Value Investments builds on his and his brother Oliver’s wonderful work with the Manual of Ideas newsletter.

The book is a  comprehensive assay of value investment theories, accompanying methods for identifying undervalued stocks, and practical considerations in the application of each strategy. John covers the following value investment methods:

  • Benjamin Graham’s “cigar butt” rule;
  • the sum-of-the-parts analysis;
  • Joel Greenblatt’s “Magic Formula”;
  • small cap stocks;
  • special situations;
  • equity stubs; and
  • international stocks.

John also suggests following great managers, and using the portfolios of “superinvestors” as a source of ideas.

The book is set out in logical, easy-to-follow format, and it is a worthwhile addition to any value investor’s library. It will be most useful to intermediate-level value investors who have developed an appreciation for the art, but not yet settled on a style. For my part, I am an advocate for “deep value,” which John limits to Grahamite net nets and subliquidation stocks, but which I define more broadly. (My definition covers most of the methods John highlights excluding Greenblatt’s “Magic Formula” for the reasons I have discussed in several posts including How to beat The Little Book That Beats The Market: An analysis of the Magic Formula and How to beat The Little Book That Beats The Market: Redux.) I highly recommend it.

Buy John Mihaljevic’s The Manual of Ideas: The Proven Framework For Finding The Best Value Investments.

Disclosure: I was provided with a free copy of the book for review, and I am quoted in it. I receive a small commission for books purchased on Amazon through this site.

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Jason Zweig has a great blog post about Dean LeBaron, founder of Batterymarch Financial Management, and pioneer of quantitative investing: the use of statistical analyses rather than human judgment to pick stocks. Batterymarch’s Dean Williams delivered the incredible “Trying Too Hard” speech from 1981, which is required reading if you’re interested in behavioral investment:

I had just completed what I thought was some fancy footwork involving buying and selling a long list of stocks. The oldest member of Morgan’s trust committee looked down the list and said, “Do you think you might be trying too hard?” A the time I thought, “Who ever heard of trying too hard?” Well, over the years I’ve changed my mind about that. Tonight I’m going to ask you to entertain some ideas whose theme is this: We probably are trying too hard at what we do. More than that, no matter how hard we try, we may not be as important to the results as we’d like to think we are.

LeBaron, 80 years old, spoke to Zweig from his home near Sarasota, Fla. He believes that the name of the game for investors has been to make as much money as possible, but from now on, the prime directive will be to “lose as little money as possible.” 

If we are in a transition period, then the person who is in the most danger is the one who has recently done well, because he’s done well on things that are about to change.

In complex systems, the dynamics are predictable but the timing isn’t. It’s like adding a grain of sand one at a time to a pile: You can’t tell when it will collapse, but you know it will.

The highlight for me is this story about one of Mr. LeBaron’s most successful techniques at Batterymarch. Every year he ran a contest to see who could pick the stocks that would perform worst–not best–over the next year. Mr. LeBaron then went out and bought them all–more than 100 at a time–believing that if you can hold on for several years:

You should make enough on the ones that don’t go bankrupt to make up for the ones that do.

It’s harder than it sounds.

Read Jason Zweig’s blog post about Dean LeBaron.

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

 

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