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Value investing: sloppy journalism lures private investors on the wrong track
Some media reports state that value can be had at a bargain price. Because of this, they are wrong.
When Cliff Asness speaks, the investor world listens. The head of the well-known hedge fund company AQR recently wrote about value investing on his blog. This investment strategy has lagged behind its previous successes for years. That's why Asness asked in the title of a blog post: Is Value Investing Dead?
Of course, the following statements confirmed Betteridge's headline law: No, value investing is by no means dead, according to Asness, on the contrary it offers disproportionate profit opportunities in the current stock market situation. Some media outlets, especially some newsletters, have included this blog entry. Some of them have to be blamed for not understanding exactly what Cliff Asness is talking about and what he is saying.
Two different value approaches
First of all, you have to know that there are two very different types of value investing. In the statistical value approach (Asness calls this the systematic approach), an investor combs the investment universe for stocks with certain characteristics, such as a low price-to-book ratio. Then he buys the titles with the favorable characteristics (low price-book value ratio) and sells the titles with the unfavorable characteristics (high price-book value ratio) empty.
With the statistical value approach, it is advantageous to buy a large number of stocks and sell them short. This reduces the risk of individual titles distorting the result in a very negative way. Conversely, it is more likely that the positive return properties of the selected stocks will be noticeable if the investor holds many stocks with this strategy.
In addition to the statistical approach, there is also the “Buffett approach” (referred to by some as “deep value”). Warren Buffett, for many the most successful of all value investors, made this strategy famous. The investor looks at all the relevant quantitative and, above all, qualitative features of an individual company until he understands it very precisely. Only when he is convinced that the value of the company is well above its market capitalization will he buy the corresponding shares.
The statistical approach is closer to hedge funds
Two things stand out. First: With the Buffett approach, the investor has to deal with a single company for a long time. Therefore, this approach leads to a concentrated portfolio with only a few stocks, with the investor having a strong conviction of each individual stock that it will bring a good return. This is not the case with the statistical approach. Second: The statistical approach, because of its selection method, is much more suitable than the Buffett approach for a strategy that includes short sales. Deep value, on the other hand, is typically a long-only strategy.
What some media reports fail to mention is the fact that Cliff Asness refers exclusively to the statistical value approach in his blog entry. And that Asness is focusing on the statistical approach is not surprising. Because the hallmark of a hedge fund is that it works with short sales. The statistical value approach is therefore closer to the average hedge fund than the Buffett approach.
Caution: Value is only relatively cheap
Now some newsletters say that Value is cheaper than ever before. But that's grossly misleading. Because value is by no means cheap. It is only favorable in relation to other stocks, for example in relation to growth stocks. That's a huge difference. An example illustrates the matter.
Suppose apples cost 5 francs and pears 6 francs. Then the price rises. Apples now cost 70 francs, pears 100 francs. In relative terms, apples have become cheaper. Previously, the price of an apple was 83% of the price of a pear. After that it is 70%. But nobody would say that apples are now a bargain.
However, this constellation is advantageous for hedge funds if they can assume that the price ratio of apples and pears will move back towards the original level. Then it is worth selling pears empty and buying apples. This regardless of how high the absolute prices are and in which direction the prices are developing. The situation is similar at the moment on the stock exchange.
Therefore, as Cliff Asness says on his blog: Value offers disproportionate profit opportunities. But mostly for hedge funds and other investors who can sell short. For private investors who can only invest long-only, the chances of making profits are significantly lower in the current stock market situation. Although the price of Value is less exaggerated than in other market segments, it is not cheap. The value euphoria of some reports is therefore not justified.
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