About two months ago an article appeared in the Wall Street Journal titled, “Advisers Ditch ‘Buy and Hold’ for New Tactics.” The article reports that investment advisers are rethinking their traditional investment approaches like buy and hold. A growing segment of the investment community is questioning their faith in long-standing investment principles, such as controlling risk through normal diversification. The stated reason for the discontent is the increase in correlation between one investment class and another, thus reducing the ability to diversify risk. Investors and advisers alike are increasingly unhappy with the results they are getting from conventional methods. As a result, financial services companies are actively creating new products designed to respond to the discontent. Some advisers are adding increasingly exotic investments, others are trading more actively, and still others are beginning to use more unconventional approaches like hedge funds, long/short funds, managed commodities, private REITS, and currencies. Change is definitely in the air.
Forgive me if I’m a little skeptical. The reason that this buy and hold tactic doesn’t work, is because it is built on the flawed and simplistic premise that ultimately stocks will go up because that is what they have done in the past. In addition to being a truly stupid reason for risking one’s hard earned money, it is buy and hold in name only. A more accurate description would be buy and hope. So when the buy and hope strategy fails, as it ultimately does, investors go out in search of a replacement. But without an objective framework for evaluating the flaw in their thinking that led them to buy and hope, like moths to a light they are drawn to the equally flawed promise of what’s working now. Buy and hope gets exchanged for trade and hope, or alternative investments and hope, or some other foolishness. In either case the results are equally dismal.
The results of this kind of behavior have been well documented in one study after another. The sad fact is that most investors do far worse than whatever funds they are investing in, because they buy and sell at the worst possible times. One such study reviewed a twenty year period ending 2007, when the average equity mutual fund was
producing nearly 12% per year. The average investor in those funds earned less than if he bought Treasury Bills.1
The solution to avoiding this dilemma is to follow the simple advice of Charlie Munger, Warren Buffet’s investment partner for the last 50 years. He said, “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”2 As noted above, most investors, professional or otherwise do not suffer because of market declines; they suffer because of their own mistakes, both individual and collective.
Our fund managers steer clear of this trap. They ignore both conventional wisdom and Wall Street advice, and stay well within their circle of competence. This means that, if, after clear reasoning, rigorous analysis, and considerable patience, they are convinced that the value of a prospective investment is worth more than its current price, they will buy it. If it continues to drop in price, they will buy even more. They will hold it until the price is equal to or greater than the value. This is the real buy and hold. In the words of one of them, “Superior long-term performance is a function of a manager’s willingness to accept periods of short-term underperformance…while deploying an unpopular strategy.” Our managers have the conviction, patience, and experience with their decision making to understand the difference between appearing foolish and being foolish. They adhere to the warning of Lord Keynes who wrote, “It is better to be roughly right than precisely wrong.”
It appears that many investors have not learned the huge lesson from the credit bubble and subsequent market collapse: ultimately fundamentals do matter. There is always a day of reckoning when the power of reality overcomes the momentum of whatever emotion is driving the market. It is this reality which forms the foundation that drives my decision making; and gives me the confidence to ignore the false promise of what’s working now, so that however uncertain the future, we will arrive there prepared.
1 DALBAR – Quantitative Analysis of Investor Behavior 2007
2 Poor Charlie’s Almanack p.8
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