By John P. Reese
In 2006, Oaktree Capital co-chairman Howard Marks wrote a memo titled Dare to Be Great in which he delivered a simple but provocative statement about investing: “This just in: you can’t take the same actions as everyone else and expect to outperform.” Being different, he argues, is “absolutely essential if you want a chance at being superior.”
Going against the herd, however, runs counter to human nature and can be exceedingly tough for investors. Just ask famed investor James O’Shaughnessy (a market guru who inspired one of the stock screening models I created for Validea) who told a cautionary stock market tale during a speaking engagement earlier this year.
The story centered around his highly-intelligent, “switched-on” friend Art, who would become extremely reactive when the market rose, call O’Shaughnessy and instruct him to go “all in” on his most aggressive strategy—one which would have done well over the prior several years. For O’Shaughnessy (founder of the asset management firm bearing his name), Art became a bellwether, a contrary indicator supporting the notion that, when it comes to investing, going against the herd mentality is a more prudent course. O’Shaughnessy, author of the stock market tome What Works on Wall Street, underscored the unfortunate yet predictable outcome of his friend’s approach. He concluded with the anecdote that Art applied this knee-jerk tactic only with respect to his own investments, not those he made for his children. “Five to seven years later, ” O’Shaughnessy asserted, “the kids were much richer.”
Marks argues, “If your portfolio looks like everyone else’s, you may do well, you may do poorly, but you can’t do different.” Most great investments, Marks asserts, “begin in discomfort.” A recent article by Collaborative Fund’s Morgan Housel echoed the axiom: “Every great investment is born from decisions that were harder than they appear to an outsider. There are so few exceptions to this. Investors have a fascination with no-brainers, obvious decisions, and easy money. The phrases should be chapter titles in a book on the ease of deluding yourself.” He cites the example of Warren Buffett’s 2008 investments in several banks, referencing the billionaire’s commonly quoted commandment: “You are kidding yourself if you think being greedy when others are fearful is as easy as saying it during a bull market.”
I don’t mean to imply that any of this is easy. Being different in any walk of life can be tough and require both intestinal fortitude and discipline to stay the course that best serves you. In his memo, Marks offers an apropos quote from Yale’s chief investment officer David Swensen:
“Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent in the eyes of conventional wisdom.”
The concept is, however, a recurring theme in many of my articles and the cornerstone of our investing strategy here at Validea: Be different and stick with a strategy through periods of not-so-good performance. This is what works in the long-run, as long as investors can remain steadfast and disciplined. One way to do this is to identify companies that reflect strong underlying fundamentals that will support their operations despite inevitable market downturns. In Marks most recent memo, published in July, he writes: “Many of the most important considerations in investing are counterintuitive. One of those is the ability to understand that no market, niche or group is likely to outperform the others forever.” At Validea, we embrace this concept.
For nearly fifteen years, we have been using the stock screening models I developed based on the strategies of some of history’s most successful investors, including Warren Buffett, Peter Lynch, Kenneth Fisher and James O’Shaughnessy. The long track records that the gurus had with their approaches, and the experience we’ve had with our guru-inspired models, tells us that these strategies have been successful not because of luck or gimmickry. That’s not to say they are successful all the time. Since our portfolios are heavily concentrated rather than index-based, they can suffer periods of significant underperformance when the market dips. On the flip side, however, this can lead to robust outperformance when upticks occur. Over the long-term, the strategies work well because they focus on basic, essential concepts that are at the core of good investing. By identifying efficient, financially solid firms with good growth and/or dividend payouts, our models are able to acquire shares of those good companies at attractive prices.
These are not particularly sexy concepts, but the gurus who inspired them subscribed to the view that successful investing isn’t about flash or excitement. Over the long term, value and fundamentals do matter. That’s why we will continue to deploy these time-tested approaches in a steadfast, disciplined way.
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John Reese is founder and CEO of Validea.com and Validea Capital Management, LLC. Validea is a quantitative investment research firm and Validea Capital, a separate company from Validea.com, which maintains this blog, is a asset management firm offering private account management, ETFs and a robo advisor, Validea Legends and Validea Legends Income. John is a graduate of MIT and Harvard Business school, holder of two US patents and author of the book, “The Guru Investor: How to Beat the Market Using History’s Best Investment Strategies”.