How To Avoid a Value Investing Graveyard For Your Portfolio
As many readers of this blog know, I believe you can create wealth investing in turnaround stocks but only if you incorporate it with a money management plan. If you don’t plan to cut your losses keep your money in a passive index fund or buy a company or real estate.
This is a strong statement backed up by my own observations from investing over 3 decades for myself and a handful of hedge funds. I have never quantified this observation by backtesting because I never had to justify it to anyone but myself and the hedge funds I worked with. My results spoke for themselves.
Now that I have started a website and blog I decided to search for academic research in regards to value investing drawdowns. My theory is that drawdowns for value investing are so large during bear markets that the majority of investors would be unable to sit through the loses without giving up and missing the inevitable upswing. Of course, a tiny percentage will sit through the drawdowns and those are the investors that everyone rejoices and reads about. It is called survivorship bias. However, these are superhumans and have the ability to take enormous pain. I know I can’t take that pain and that’s when I started implementing a stop and reenter method 20 years ago. My life is much more pleasant now that I am no longer an evangelical value investor.
Well, it seems I have found some research that backs up my observations. It comes from a recovering value quant that learned the hard way how hard it is to be a value investor. He was such an evangelical value investor that he wrote a dissertation on how wonderful value investing was.
His criticism of value investing is highlighted in two articles, “Value investing is quite possibly the worst idea…EVER” and “Value Investing: Digging Manager Graveyards Since 1963”. The author is wes gray a finance professor.
Here are two comments from the articles. “Value investing is really a tragic story of pain, anguish, and heartbreak that never really has a happy ending. The expected gains are almost always offset by extreme relative performance pain. Are investors prepared for 6 years of tragic underperformance? Cliff Asness traded a live value strategy and lived through a 50%+ drawdown in the late 90’s when the market was cranking out 30% CAGRs. To say that Asness had brass balls would be an understatement–he had diamond crusted platinum balls (or as a reader suggested diamond-crusted tungsten carbide balls)! He goes on and says, “
If you are an emotional and impatient investor, you should think twice before you invest in a value strategy”. Trust me 99% of us are emotional and impatient. His articles points to the quantitative data that back up his claims. I won’t go into that data in this blog post. I suggest you read the articles.
If you are a new value investor please take his words and mine with serious consideration. If you are a seasoned investor you most likely have the value investing scars to acknowledge our concerns.
However, don’t despair. Value investing can create real wealth. All you have to do is incorporate a stop loss and a reenter strategy. You have to think like a card counter and not place a bet unless you have a reward to risk ratio of at least 5 to 1 and maintain a money management plan that preserves your physical and psychological capital and limits drawdowns. This allows you to continue probing for a bottom in a stock as you wait for a break upward in its downtrend. If you are an evangelical value investor you will be blown out before a bottom takes place and unlikely to buy more as the stock makes its true bottom.
If you’re interested in learning how to be a card counting value investor consider becoming a member of turnaround stock investing.
