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Suppose that over the last few years value investing had outperformed, what would happen? It would be back on the radar again and investors would want to ensure their portfolios are positioned to exploit the value premium. It gives them a good feeling because many believe in value investing and admire great value investors such as Benjamin Graham and Warren Buffett. There is also a tremendous amount of academic literature that confirms the existence of the value premium.
But before they overenthusiastically start trying to capture that value premium, they should learn from the mistakes often made by investors. So what goes wrong? Investors convince themselves that their search for value managers is based on academic evidence and the great performance of famous value investors. Or is it the recent good performance of value stocks? They are happy with the managers they have chosen to provide the consistent value exposure they seek. But then, after a while value investing starts to lag behind the market and those investors that have so proudly recruited a value manager start to get nervous.
Why does this happen? Well, in the same way that children behave in a candy shop, these investors focus on the historically strong returns of value stocks and admire the intelligence and creativity of the great value investors! But they forget just how patient these investors have had to be to achieve their great returns and how irregular the performance of value stocks can be over time.
They also forget the extent to which Warren Buffett’s returns lagged during the IT bubble at the end of the 1990s (when people made fun of him and even wrote him off because he failed to jump on the bandwagon) and also how strongly his performance recovered.
And last but not least, they overlook the length of investment horizon you need to achieve great value returns, and we’re not talking about a short 3-year performance evaluation period in this case.
So entering a value strategy after a few years of good performance, backed by the sound philosophy and results of great value investors and academic proof, is not enough especially if you fire your value manager again after a few years of lagging performance. Impatience ‘kills’ the potential results that looked so promising when you selected your value manager.
Not only do you fail to give yourself the chance to capture the value premium, worse still, you probably achieve returns that are far below those of the market. This is a tragedy for your clients – after all it’s their money that is being eaten away! And all because you didn’t have the character to be patient and stick to your highly promising value investment philosophy.
‘I’m convinced that if impatient investors really take a good look at themselves, they will see where they went wrong’
If you can’t handle the irregular return on value stocks, don’t have enough patience, are afraid of difficult questions from clients, your manager or your investment committee, be realistic and stop recruiting value managers. Start investing in an index fund, cut costs (fire people), reduce your career risk (if you still have your job, that is!) and deliver a better return for your clients.
I’m prepared to admit that I can’t provide the same amount of empirical evidence to prove this investor impatience as I can give you on the existence of the value premium itself. But I’m convinced that if impatient investors really take a good look at their investment behavior, they will see where they went wrong. In the end, there’s only one major advantage related to their behavior – it keeps the value premium alive and kicking!