- Peter Kinkaide
The Horns of a Dilemma
As an investment advisor, long bull markets can both exciting and fulfilling as well as nerve racking and terrifying. It’s the final stages of bull market that can really wear a traditional value investor down. This is mostly due to the fact that by the time markets reach those dizzying heights seen at such a bull’s latter stages, value is almost nowhere to be found. For those who practice dyed-in-the-wool value strategies, these final years can be agonizing for their returns, for their funds’ confidence, and their managers’ psychology.
The bull market which started sometime in 2009 after the Great Credit Crisis has now run nearly 11 years with a few corrections. At Nintai Investments, our average investment partner portfolio has jumped from roughly 25% below fair value to 11% above fair value since 2018. We simply don’t find very much value out there. As an investment advisor, we face several choices when it comes to the allocation of capital – establish a new position, add to an existing position, stand pat/build cash, take profits, or exit a position entirely. The greatest impact on which course to take is that of valuation. With rising valuations over the past decade, nearly every decision has led to either standing pat and building cash (on average near 20 - 25% in our investment partner portfolios) by taking profits. These actions have placed us in an awkward position. Holding a large percentage of portfolio funds in cash is no way to outperform in bull markets. Yet, as a true value investor, I refuse to overpay and potentially open up our partners to permanently impaired capital.
For the past several years we’ve been in a rather inopportune position of having our feet stuck in the mud as other investors have raced by achieving outstanding returns. What makes this so painful is that our long term record - achieved through bull and bear markets - of significant outperformance has been cut dramatically. As an example, on June 30 2020 our average investment partner portfolio had achieved a three year cumulative return of 87% versus the S&P 500’s 31% return - a 56% difference. At Nintai, we were sitting up a little straighter and walking with a little extra swagger after we reported that quarter. But - like all those who suffer from hubris (small or large) - it only took 3 months to teach us that inviolable law of reversion to the mean. By September 30 2020 that 56% outperformance had dropped to a 26% differential. Of all of that hard work and gains achieved over three years, we lost over one-half in just over 90 days. Ouch!
Don’t get me wrong - we aren’t crying in our New England clam chowder here at Nintai Investments. We are doing what we’ve done for nearly 20 years - maintaining open and honest communication with our investment partners, redoubling research on our portfolio holdings, and being cognizant of our emotions during this dreadful period. Our long term performance continues to give us confidence in our process. In addition, we are blessed with partners who understand the power of patience and have faith in our methodology.
Value Investing: A Wide Range of Underperformance
Of course, Nintai isn’t the only investment house in this position. While we had a very rocky 2020, some famous value investors have underperformed dramatically over the length of the bull market. For instance, what would your initial thoughts be of an investment manager that had the following summary description? Would you feel comfortable giving your entire retirement assets to such a fund?
“On a three-year basis, the fund currently sits 1,514 out of 1,516 fund managers in the Equity - Global sector. He lost 53.2% over the period to the end of March 2020 (3 Years), while the average manager in the sector lost 1.3%.”
Yikes. That performance was chalked up by Francisco Paramés’ Cobas Asset Management. Many people will remember Francisco from his prior investment venture - Bestinver - where he was employed for 25 years (leaving in 2014) and posted a 16% annual return over that time. For longer term underperformance, one doesn’t have to rummage around very long in the value investor hall of fame. For instance, Bruce Berkowitz’s Fairholme Fund (FAIRX) - Morningstar’s Fund Manager of the Decade in 2009 – has underperformed the S&P 500 by -16.8% over the last three years, -10.3% over the last 5 years, and -8.5%over the last 10 years. During the decade assets under management decreased from $11B to $650M. David Winters - former guru manager at Franklin Mutual before founding the Wintergreen Fund - underperformed the S&P 500 by -10% over 3 years, -10.6% over 5 years, and -6.9% over 10 years before closing the fund in 2018 after seeing AUM drop from $950M in 2013 to $10M in 2018. Third Avenue Value Fund - Marty Whitman’s died-in-the-wool value vehicle - has really taken a beating. It has underperformed the S&P 500 by -14.2% over the last 3 years, -10.3% over the past 5 years, and -9.1% over the past 10 years. Assets under management have decreased from roughly $5B to $390M.
I didn’t write this to ridicule my fellow investor managers or hold them up as individuals who’ve lost their touch. Far from it. I give them credit for sticking to their process and moral compass. Rather, I wanted to point out that nearly every value investor has been pretty badly damaged by the last decade-long bull market. These three represent a cross section of styles, methodologies, and asset portfolio that differ dramatically. The one common theme is they all derived from the classic school of value investing. The second theme is they have all underperformed (some less than others).
Is Value Investing Obsolete?
As investors peruse the wreckage over the last decade within the value investment landscape, many people have begun to ask whether value investing has seen its day. It’s easy to see why that is being asked. As you look out across the investment universe, you can find a considerable amount of classic value investors with truly appalling 3, 5, 10, and even 15 year records. This underperformance has cut across nearly every category (small, mid-cap, large, and jumbo). For instance, the Russell 1000 GROWTH Index through June 30 2020 has achieved a 1 Year return of 23.3%, a 3 Year return of 19.0%, a 5 Year return of 15.9%, and a 10 Year return of 17.2%. (return data provided Vanguard). Compare this to the Russell 1000 VALUE Index 1 Year return of -8.8%, 3 Year return of 1.8%, 5 Year return of 4.6%, and a 10 Year return of 10.4%.
As value investors (and I include myself as one), one has to look real hard to see any positive message in returns like that. Over a decade, it becomes increasingly difficult to convince investors that value is simply “out of style” or “we’ve all seen this type of cycle before”. One only has to look at the bull market of the mid to late-1990s to see that growth outperformed for only roughly 5 to 6 years. As of 2020, we are looking at growth outperforming vale by roughly 12 years - nearly double the tech bubble cycle.
These types of returns have begun to really bite into traditional the value investor business model. For instance, data from Lipper showed U.S.-growth funds attracted $17.6 billion in April and May of this year, while value funds witnessed outflows worth -$16.9 billion. Numbers like that are nothing to sneeze at. Assets under management have dropped dramatically for many value gurus. Vanguard reports the average actively managed Value Large-Cap fund has lost 38%, the average value Mid-Cap fund has lost 42%, and the average value Small-Cap fund has lost a whopping 62%.
So is value investing obsolete? At Nintai, we feel very strongly the answer is no. As silly as it sounds to say consumers will no longer look to find groceries on sale, we think there will always be a role for value investors to sniff out value and make their investment partners handsome returns arbitraging the difference between price and value. That said, we think some things will need to change if value investment theory is to thrive in the future. Some traditional methodologies need to be discarded while existing/future trends need to be embraced.
Potential Changes in Value Investment Strategy
At Nintai, we think the 21st century will be a golden age for value investing. Having said that, we think the golden age will be powered by the adoption of new technologies and trends and the phasing out of certain methodologies or measures that may not be as effective as they were in the past.
Information is a commodity now
Back in the days (and I date myself here), value investors used to take the latest Value Line report and read about hundreds of companies analyzing essential data derived from the companies’ balance sheet, cash flows, and income statement. You paid good money, but there simply was no better source of data in one place. This was further enhanced by the adoption of Morningstar’s fund data (later increased to stock and individual bond data) and the Bloomberg terminal. Unfortunately, all of this data has been digitized and is now available on a single platform with the ability to utilize your own proprietary algorithm to search for investment opportunities - all at the push of a button. What once took considerable dollars and even more time can now be done in seconds. Hidden gems - even including Ben Grahams net-net opportunities are now as simple to find for your next door neighbor as they are for a senior analyst at JP Morgan.
Company disclosure is available at the touch of a button
Learning about a company - everything from management compensation to chief competitive offerings –- is possible right on the company’s website. An enormous amount of content such as investor presentations and conference slide shows - not to mention 10-Qs, 10-Ks along with other SEC filings - is at the fingertips of any potential investor. The days of finding inside information or having an inside source really isn’t even an issue anymore.
Investment strategy and theory is just as easy to find
Many older value investors first became cognizant of value investment theory and methodology by picking up the 8 pound hardcover version of Ben Graham/David Dodd’s classic “Security Analysis” and settling down to take copious notes and trying to match the authors’ thinking with Marty Whitman’s thoughts on calculating intrinsic value. That certainly isn’t necessary anymore. Today one can search Amazon’s business section to finds thousands of books discussing everything from modern investment theory to detailed arbitrage strategies. The ability to learn about investing - from the highest theory to the meanest methods - simply cannot compare to what it was like in the 1980s.
These trends have leveled the playing field for all investors – whether they be growth or value focused, individual or institutional in size - limiting the ability to have an inside track because of corporate, competitive, or marketplace information. This has had a tremendous impact on value investors where accurately calculating the difference between value and price is the essential tool in achieving outperformance.
But sometimes these trends aren’t just a detriment for value investors. For instance, while the digitization of data has leveled the field in terms of knowledge, it has also fed on the impatience of today’s investors. Rather than let all this new knowledge work for them, many investors use it to do short-term or - god help us - day trading in the markets. Here’s a few instances where new trends can be inverted to the advantage of the value investor.
Research can be far more robust
While digitization of data has made research available to anyone with an internet connection, most individual investors have a difficult time utilizing this new asset. Indeed, many investors have been lulled into simple algorithms/search tools like “Warren Buffet’s Stock Buys” and think they can buy stocks within the search results and voila(!) they are seemingly a partner at Berkshire Hathaway. To obtain value from this influx of data, individual investors need to roll up their sleeves, develop a set of investment goals/investment criteria, and then utilize search features to identify possible investment targets. While many think this is the end of the research, true value investors know this is just the beginning. Being able to screen useless data, applying good data to answer critical questions (such as “what are the three major components of the company’s moat and how are they supported by returns on capital?”) takes enormous effort.
Digitization means more actions at faster speeds
We are beginning to see that the explosion in the amount of data is also increasing the velocity in which the data is used. According to Vanguard the average ownership time of a portfolio holding has decreased from 5 years 3 months in 1965 to less than 3 days in 2019. In some cases (such as Nasdaq or commodities trading) the holding period is measured in hours or - heavens forbid - seconds. Value investors can use this form of hyperactive disorder to purchase shares of outstanding companies at fair prices and then let time (meaning years) do its compounding wonders. Since beginning Nintai Investments LLC, our average turnover has been less than 5% annually with 75% of our holdings in the portfolios since inception. If you find an outstanding company headed by outstanding capital allocators, why not let them do the heavy lifting?
Great businesses are lasting longer. Poor companies are not.
In the good old days of value investing, the idea was finding companies selling below their total net assets or operating under some impairment such as a bad business deal or bad news. One simply had to scoop up the shares at a discount, wait for the market to recognize its mistake, and sell the shares when they reached fair value. It’s not so easy anymore. At Nintai we find companies that take a hit - for whatever reason - have a tendency to stay down for quite a long time. A recent example of such an extended price depression (or as it is called - a “value trap”) is AK Steel Holding (AKS). After peaking at roughly $17.50 per share in January 2011, the stock has slowly and steadily dropped to $2.25 per share at the end of 2020. Every event which has toted to be “turning point” has not panned out - selling assets, rebound of oil prices, etc. - and simply provided patient investors with a 90% loss of their investment. With the amount of data publicly available these days, simply betting on a company selling at a discount to its assets and waiting for the markets to price in a market catalyst is a disaster. At Nintai we think one of the reasons why a company like AK Steel can be a value trap is that it is much harder to find mispricing through hidden or misunderstood assets. In the past, many capital intensive companies (like AK) could prove to be a profitable investment when a security analyst found mis-priced assets hidden on the balance sheet that eventually reached full valuation through an asset sale or divestiture. Such extensive information and data available these days makes it much harder to find such mis-pricing and simply find a value trap instead.
At Nintai, we don’t believe value investing is dead. We would argue it has evolved as changes in informatics, corporate disclosures, and business velocity have altered the investment landscape. We think investors with the emotional ability to be patient and not overpay, combined with the ability to utilize all the data and information available, will be rewarded in the long term. The ability to find stocks with low PE or PS ratios or trading at 40% of its net assets simply isn’t enough these days. Neither is using some algorithm based on a formula to find “cheap” stocks enough. The playing field has flattened which has created both an opportunity and a risk. The truly successful value investors in the future will understand this and utilize the changes over the past 25 years and use them to their advantage in the next 25 years.
As always, I look forward to your thoughts and comments.
DISCLOSURE: Nintai Investments – nor its investment partners – own any stocks mentioned in this article.
 I can remember sitting at Well Beach spending a week in the sun, watching the surf and reading 8 different Value Line reports all week. I could slice and dice all this data today in a matter of minutes – not weeks.