Investment Approach & Differentiation
„The first rule of investing is don’t lose money, and the second rule is don’t forget rule #1”
Value Investing was developed by Benjamin Graham at Columbia Business School, New York, in the 1920ies and has been taught there for many decades. Graham’s books “Security Analysis” and “The Intelligent Investor” are considered important guidelines for every value-oriented investor until today. Value investing has evolved over the years and different styles have developed. Value Intelligence Advisors GmbH have dedicated themselves to a relatively modern and risk-averse interpretation of the value approach. The stylistic role models include first and foremost Warren Buffet and Jean-Marie Eveillard, two of the most successful investors of all times. The risk-averse form of value investing is still not very common in the German-speaking world. This is odd, since the characteristic combination of attractive long-term return and defensive risk profile is actually in line with the ideal investment objectives of most investors. With our work, we want to help institutional investors take advantage of this approach. We are convinced that a strong focus on the preservation of capital is not necessarily detrimental to performance – quite the opposite! Avoiding losses is a key precondition for generating attractive, long-term yields.
„In the short run the market is a voting machine but in the long run it is a weighing machine.“
The application of the value approach is demanding and requires both the investor and the practitioner to be patient and disciplined. Benjamin Graham’s description of the value approach is still valid today: While emotions influence stock market pricing in the short-term, rational criteria and fundamental values determine it in the long-term. For the successful application of the approach, an investment horizon of three to five years is needed. Since there are only few investors who can exercise the necessary patience and discipline, value investors represent a small minority in the market. The fact that the most successful representatives of this minority are in almost all the top positions of the long-term rankings of the fund rating agencies, emphasizes the credibility of the value approach.
„The secret has been out for 50 years (...) yet I have seen no trend toward value investing (...) it is likely to continue this way. (…) Ships will sail around the world but the Flat Earth Society will flourish. (…) There will be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper.“
Warren Buffett, 1984
Capital market research of the last decades has to a far extent refuted the theory of efficient markets. After the discovery of numerous empirical anomalies, the focus of capital market research shifted to the question of what was causing these anomalies and why people sometimes act irrationally in the capital markets. It was shown in many studies that, e.g., over-confidence, herd mentality and loss aversion are part of human nature and therefore potential sources of inefficient pricing on the stock markets. Despite these findings and several Nobel Prizes for leading academics of behavioral finance research – Kahnemann (2002) or Shiller (2013) – no sustainable change in the average investment behavior of the market participants can be observed. There is considerable evidence that human nature and the related anomalies are very stable over time and that value investors can therefore still profit from it and generate attractive returns over the next decades.
„It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
When selecting stocks, we prefer companies of high quality. High-quality companies can normally be recognized by their stable return on equity, attractive free cash flow yield and a sound balance sheet. Funds at the quality-end of the value spectrum generally have an attractive risk profile. Compared to funds at the Graham-end, they are characterized by lower standard deviations and lower max drawdowns. We consider quality stocks a proven and up-to-date investment. Shareholdings in companies with strong pricing power and stable margins can produce relatively good results in both an inflationary and deflationary economic environment. For the risk-averse investment strategy of the Value Intelligence Fonds AMI, which in the short-term always focuses on capital preservation first, high-quality companies are therefore particularly well suited.
„Market commentators and investment managers who glibly refer to „growth“ and „value“ as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component – usually a plus sometimes a minus – in the value equation.“
Value Intelligence Advisors GmbH is basing the valuation of companies on analytical methods in the tradition of Benjamin Graham, Warren Buffet and Columbia Business School, New York. Like all value investors, we differentiate very carefully between price and value when investing in listed companies, and only consider an investment if there is a sufficient margin of safety. Contrary to common belief, we do not consider the “value approach” to be the opposite of the “growth approach”. With this we are in line with the more recent teachings of Columbia, which have been significantly influenced by Warren Buffett. According to these, growth may be taken into consideration as increasing the value of a company, especially if sustainable competitive advantages and market entry barriers protect it. Therefore, the term “growth” is not a suitable differentiation. The long-term value investing approach is, in our opinion, better described as the opposite of the short-term momentum approach.
„You must know the big ideas in the big disciplines and use them routinely – all of them, not just a few. Most people are trained one model (…) and try to solve all problems in one way (…) This is a dumb way of handling problems.“
Apart from the bottom-up approach in the tradition of Columbia Business School, we also apply two other theoretical concepts – especially for portfolio construction and risk management: the value-oriented, empirical capital market analysis and the Value Intelligence Consensus, which we developed by aggregating the opinions of the best global value investors about long-term macro trends, asset allocation and stock picking. We are convinced that the application of several different theoretical concepts is helping us to identify potential dangers at an early stage and to reduce the error rate significantly.