Even as the wreckage of financial giants continues to dominate business headlines, value investors are making the case for long-term fundamentals. And it might be just what the market needs.
At the AIC roadshow this week, investors and advisors packed the sprawling Carlu ballroom in Toronto to ascertain whether or not value investing could really be the answer to the tumultuous market.
It came as no surprise that each of the value managers affiliated with AIC’s offerings declared a definitive yes: value-investing is the prosperous way to create and maintain wealth. And perhaps the knight-in-shining-armour for a beleagered, cash-strapped market.
“Crisis equals danger and opportunity,” explained Jonathan Wellum, CEO of Burlington-based AIC.
Despite exposure to AIG — which was bailed out this week by the U.S. government to the tune of $85 billion — and Lehman Brothers — which filed for bankruptcy early this week — Wellum and others were convinced that the value-investing long-term approach was the right prescription for what was (and is) an over-leveraged market.
“People are looking to dampen volatility and they are looking for one-stop solutions,” said Wellum. “But it’s not about beating the market; it’s about working with the market and seeing value.”
It is a perspective long held by the don of deep-value investing, Marty Whitman. The New York-based founder of Third Avenue, a deep-value firm with a specialization in U.S. and global equities and real estate, was eager to convey that, despite the headlines, now was a great time to invest.
“It seems to be there are great values out there now,” said Whitman. “It’s time to buy stocks that are safe and cheap.”
The 84-year-old Whitman continues to oversee the firm’s flagship mutual fund, Third Avenue Value, a global fund which boasts an average annual return of 14.4% since its inception in the early 1990s.
“Safety comes with quality,” explained Whitman, and quality comes from good, strong financial fundamentals that include a focus on net asset value (NAV) and strong corporate management.
“Most of the world is more interested in wealth creation then cash flow; yet cash flow is essential in the creation of wealth,” explained Whitman. The octogenarian continued his criticism of how most investors operate by saying that “diversification is a poor surrogate for knowledge, and knowledge gives you control.”
For the value investor, the way to control risk is “to examine the investment and ignore the market,” explained David Boarse, CEO of Third Avenue.
According to Whitman, recent market events were “the most severe financial crisis” he has ever seen: worse than the U.S. savings and loans crisis in the 1980s; the Asian currency crisis of 1997; the 2000 collapse of hedge fund Long-Term Capital Management; and the Russian default crisis in 1998.
But like any good value-investor, who examines and moves based on the long-term, Whitman was confident: “This too shall pass.”
As a result, Whitman believes in the value-investing philosophy — buying companies that are very well financed, whose stocks are priced at a substantial discount to net asset value (NAV), and where the business has the potential to grow its NAV by at least 10% a year over the next five to 10 years.
“If the value is compelling enough and the businesses have staying power, we just buy and don’t worry about the market,” Whitman said. As a result, the turnover of stocks is about 10% to 15% a year and the majority of that is due to “companies that get taken over, rather than a sale [of stock].”
Whitman confessed that “when we invest in the near-term, the outlook sucks.”
And right now the market sucks.
But according to Whitman, Boarse, Wellum and the other managers participating in the AIC roadshow, this is good for value investors.
With excellent access to capital, value investors are digging around, looking for those good buys. This infusion of money into a relatively illiquid marketplace is exactly what companies with good fundamentals need.
Take for example, Disney, said Charles Bobrinskoy, vice-chairman at Ariel Investments and co-portfolio manager of AIC American Focused Fund.
Between 1985 and 2008, Disney’s projected compound annual growth rate (CAGR) was 16.5%; yet, the company’s actual CAGR was 5.7%.
“Disney is doing something very, very right,” explained Bobrinskoy, “but the market is treating it as if it is going out of business.”
Bobrinskoy’s belief in Disney meant his fund took a strong hold in the company in July 2007, and he states, “We are very pleased with that.”
Like Whitman, Bobrinskoy believes markets, like investment banking, are “wildly cyclical,” and that the challenge — best suited to the value-investing mentality — is to “ignore the market noise and concentrate on the investment.”
Bobrinskoy also chimed in to the overall sentiment among the value investment managers that the worst is yet to come.
“The U.S. looks like Japan in 1989,” he said. “Instead of facing the problems [systemic in the market] and letting banks fail, the U.S. government is doing exactly what the Japanese [government] did [bailing banks out]. So consumers will suffer for the next 15 years and stocks will stay stagnant.”
Despite this bleak overview of the state of the U.S. economy, Bobrinskoy believes that value-investors can find good deals outside of America — a tactic American corporations have already started to implement. “Tiffany will be 50% Asia-owned by 2010; others are following suit.” Including investors.
Originally published on Advisor.ca on September 22, 2008