Tuesday, May 31, 2011

Value Investing's Long Run

The folks at Ben Graham's alma mater (and where he hung his hat ) may know something about the subject.
From Columbia's Ideas@Work blog:

What the gradual turn away from modern portfolio theory holds for value investing. 
The finance discipline is in the process of a halting transition. The efficient markets/modern portfolio theory is giving way to broader perspectives that incorporate the realities of information asymmetry — the fact that all market participants do not have the same access to relevant information — and deeply ingrained behavioral biases that often dominate actual financial market outcomes. At the leading business schools these latter approaches are now firmly established even though in the finance profession at large they remain relatively unfamiliar.

One particular aspect of this change is the increasing importance of value investing, an approach to investment management pioneered by Benjamin Graham and David Dodd ’21 at Columbia. In part, this is due to the overwhelming success of the value approach in practice. Individual value investors like Warren Buffett and value-oriented institutions like Sanford Bernstein populate the ranks of outstanding investors out of all proportion to their numbers. However, it is also due to a detailed appreciation of the way value investing differs from more conventional approaches, how this is responsible for the historical success of value investors, and why it is likely to continue in the future.

Traditional characterizations of value investing have been overly simplistic. Value investing involves buying securities at one-third or greater discounts to their “true” values, effectively buying dollar bills for fifty cents. More recently we have begun to appreciate how a value approach is distinct in the particular areas of searching for investment opportunities and valuing companies.

In search, the value strategy is to look in areas that are obscure, boring, unattractive, and therefore cheap by common metrics like low market-to-book and PE ratios. Simple statistically constructed portfolios of such stocks produce above average returns in cross-sections of securities over all extended time periods in all global markets. (My colleague Tano Santos shows this in his take on the question.) In time-series, there are reliably predictive levels of positive serial correlation in short-term returns. Neither phenomenon should be observed if markets were perfectly efficient. (Attempts have been made to associate the higher cross-sectional returns of “cheap” stocks with higher levels of risk, but these risk factors never turn out to be empirically measurable independent of cheapness.)...MORE
HT: Simoleon Sense

For some reason I keep thinking I should have drunk more champers.
[his is a hopeless case. He sees the headline, cross-wires to the famous Keynes quote, barrels along to the last words attributed to J.M.K and wonders 'Where was I?' -ed]

Also at Ideas@Work:
Untangling Skill and Luck