Compound interest is the first (popular) discussion that's worth repeating:
if the Manhattan Indians had been able to invest the $24 for which they sold Manhattan in 1626 at, say a net return of 8%, their heirs could buy it back now (1968) with all the improvementsThis is just the beginning, however:
Buffett then brings up the "three very strange dice." Labeled as A = A=(2, 2, 2, 2, 5, 6), B=(1, 1, 4, 4, 4, 4) and C=(3, 3, 3, 3, 3, 3), two people can play a game where each chooses a dice to roll. The person with the highest number then wins that round. Interestingly enough, through repeated games (and deduction) it can be shown that A > B, B > C, but C > A. They dice are intransitive. As a result, the 2nd person to pick a die should always win in the long term by # of wins if he/she recognizes this. Just like rock paper scissors, no pick is universally best.
In other words, in such a game and indeed the market a strategy's success is often very much dependent on the others being employed. I would argue that the very reason for value's outperformance in 02-03 post-dot-com crash is because of the focus on speculative technology stocks. Similarly, active investors want more short term speculators and index funds because they would provide the other side to profitable buys. On the other hand, if everyone is preaching value or quality businesses a la nifty-fifty, value investors may want to stay away.
This phenomenon is indeed well-known already, but the examples above and detailed in Ed Thorp's paper show just how pervasive and powerful this quality is.
I agree with your point that various strategy's depend on what other's are doing. However I also think that a lot of people we paint as a "value" investor or what have you are in reality more hybrid types.
ReplyDeleteBuffett, for instance isn't necessarily a true Graham/Dodd investor because he doesn't rely on the so-called "cigar butt" stocks that are so dirt cheap but have one good "puff" left in them. He pays premiums for great businesses with a moat. He also utilizes derivatives and warrants which might be considered riskier trades.
The interesting thing with activists, in my opinion, is that they have an advantage over private equity in that they are buying at a discount relative to what a PE firm would pay since they buy shares through the market. That is a real advantage.
True! "Value" is has definitely been too-broadly used for very different strategies. From Tilson's value investing congress etc. to Columbia's value investing program, there is no shortage of that phrase, despite big differences between graham/dodd, buffett, einhorn, klarmen et al. It is unfortunate though that many of the well-known value specialists such as tweedy browne, third avenue, even miller @ legg mason have essentially been run over in the last 5 years.
ReplyDeleteRe: activists - I do agree they have an advantage in price, but that is counter balanced by lack of full control? They have to wage proxy battles vs just make the changes directly.
I think that it depends a lot on the size and the current financial state of the target company. If a company is smaller and in a more precarious financial situation I think that it can be easier for an activist to take control whereas going after a larger, better capitalized firm can cause quite a headache. However there is something to be sad for getting in bidding wars and losing, it can be a good way to make a quick profit!
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