While preparing future posts, I have reflected on the Market's past fortunes and Fortuna's beckoning winds of change..
Thus I have just read an interesting paper by Louis Lowenstein, Rifkind Professor of Finance and Law at Columbia University on the fortunes of the top-ten value investment funds in relation to the S&P 500. The paper is titled 'Searching for Rational Investors in a Perfect Storm'. Lowenstein's paper claims the value funds outperformed the Index 11% year-on-year with purchases limited to 34 stocks or so with low churn.
Regarding the 90's runup of the NASDAQ and the mutual fund industry's 'speculative pyrotechnics', Lowenstein claims that EMT enthusiasts and tenured scholiasts had very little to support their position on 'homo economicus'. According to Professor Lowenstein,
' Obviously the theory was wrong – woefully so. In the late 1990s, stocks soared to levels out of all proportion to their underlying values, indeed to levels well beyond even the excesses of the 1920s. If the NASDAQ Composite Index, for example was right at 1200 in April 1997, it surely wasn’t right at 5000 in March 2000, and then right again at 1100 two years later. (The
rise and then almost 50% decline of the broader based S&P 500, though widely noted, was also stunning)'.
Assessing value performance against the market average, Lowenstein lined up the ten value funds against the declining S&P 500 between 1999-2003. With negative annualised return of 0.57%, Lowenstein suggests all ten value funds were healthily up, a five-Sigma event for the quants. The ten funds are as follows: Clipper Fund, Mutual Beacon, FPA, Capital Oak Value, First Eagle Global, Oakmark Select, Longleaf Partners, Source Capital, Legg Mason Value and Tweedy Browne American Value. Not one of these funds held 'hot stocks', Cisco, Nortel and Enron!
The returns map as follows:
Clipper 11.9%
FPA Capital 15.29
First Eagle Global. 17.02
Legg Mason Value 4.43
Longleaf Ptners 10.94
Mutual Beacon 10.28
Oak Value 2.63
Oakmark Select 15.43
Source Capital 15.22
Tweedy Br. Amer. 4.87
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Average annual returns for the five years:
Group Average 10.80%
S&P 500 Index -0.57%Obviously I am not offering, and cannot offer, investment advice but the paper is worth reading and, I think, points to valuable advice... Check it out for yourself.
One more thing. Reading British economic historian, Lord Robert Skidelsky's excellent, Keynes: Return of the Master which features a robust attack on EMT and the Rational Expecation Hypothesis. Skidelsky, recommended to his reader by Paul Krugman, includes a very succint discussion on the Gaussian bell-curve, and the associated dangers of 'bell-curve' risk management and modelling. Should be read in conjunction with paper above.
In addition, Lord Skidelsky extols the benefits ("sells the benefits" in industry parlance) of non-finance related pursuits particularly as this aids long-term investment. Keynes, though he lost three fortunes(!), nevertheless ended up with a positive ledger enabling him to live 'wisely, agreeably and well'. Would that we could all do the same!
Finally, refer to authors Joshua Coval, Jakub Jurek and Erik Stafford for their Harvard paper, 'The Economics of Structured Finance' regarding the rise and fall of structured credit. The authors peer into that darkened mirror to review the default complexity - Nassim Taleb would argue 'convexity' - of CDOs and CDOs squared and the growth of the subprime industry. The authors acknowledge the limitation in pricing appropriately for higher-yield when faced by undiversiable, systematic risk caused by a failing economy.
I will have more to say on this later. For the moment, I would submit that the ratings agencies did not cultivate the 360 hindsight I mentioned in the past, which attitude may have enabled them to view market risk 'in the round'. (Then again, the value investor's real skill, Graham, Dodd, Keynes and Lowenstein will tell you, lies in discarding hindsight bias for qualitative foresight - not absolute predictive power, but prudence).
When sufficiently prepared with data, I would also contest that market participants, agencies and everyone else(?!) could have adopted a more cautious, synthetic/creative outlook on the portfolio analytics and credit spreads to determine whether the industry was truly indulging in too much of a good thing.. At the same time, there is ample room here for vintage behavioural analysis a la Robert Shiller, in order to sample the 'vintage', as Joshua Coval, professor of Administration at Harvard Business puts it, of the last few bottled years of credit quality, and 'overcollateralized' bond spreads. In any event, fortunes rise and fortunes fall and 'men', as Tocqueville observed, 'are forever rising or sinking in the social scale'.
Regarding the structured credit run-up to 2009 meltdown, therefore, I sense the presence of the Goddess, Fortuna over my shoulder. Where will the industry go now?? But more on that another time.
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