Can We Find a Cure for Aging?...

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According to Joseph Coughlin, an expert on aging and founder of MIT’s AgeLab, there are two simple questions that can determine how well you’ll navigate your later years: “Who’s going to change the light bulb, and how are you going to get an ice cream cone?” These appeared in a recent New Yorker article by Adam Gopnik, who visited Coughlin at his AgeLab.

These two questions pretty much cover things. The light bulb is about how you deal with the small tasks you never used to think about but that start requiring effort as you slow down and begin to ache and creak. The ice cream cone is about what you can access and enjoy in the world at large as you age. How far away is that ice cream cone? What if you can’t drive? What if you have no one who can bring the ice cream cone to you?

There’s a lot that can be done in the way we design homes, communities, products and services so that older people can live easier, fuller lives for longer. That’s one way to think about improving the experience of aging – and that’s what Coughlin, who wrote a book called The Longevity Economy, is interested in doing.

But there is another way to think about the challenges of aging. David Sinclair, a researcher on the biology of aging at Harvard Medical School, invites us to imagine this: Your doctor notices when you are 45 that your blood sugar is getting high and that you’re losing muscle mass. “Listen,” your doctor says, “I see you’re starting to age, so let me give you something for that.” That could mean holding off cancer, heart disease, dementia and other age-related illnesses for long periods of time.

As incredible as this may sound, it may no longer be so farfetched. There are dozens of companies and labs researching different pathways to extend human lifespans. Scientists already have expanded the lifespans of simple organisms like yeast and worms and extended that to animals like mice and monkeys. The study of aging is moving to the forefront of science – and it’s not the 20th century way of tackling one disease at a time, but a focus on treating aging at its source.

It all may seem a bit fantastic, but there has been a significant shift in the way we think about aging. Until very recently, we have viewed aging as a natural process – something inevitable to be accepted and managed. But now scientists are starting to think that there’s no valid reason for aging to be inevitable. They are thinking that aging might involve issues at the cellular level that can be corrected. In effect, they are thinking of aging not as a natural process, but as a disease that can be treated.

That’s a huge mental shift. The consequence is that aging research is getting much more attention than it used to. Sinclair noted in a recent interview that researchers focus on what is considered treatable, not what seems inevitable. This was true of cancer, which was considered a natural part of life for a century, but when it was shown in the 1970s that the disease process could be modified, the thinking changed.

Multiple pathways to counter aging are being explored. Perhaps the most interesting is cellular reprogramming, which involves introducing a combination of genes into an animal’s cell and seeing if that tissue rejuvenates as if it’s young. Essentially it is taking old cells and turning them into young cells, and it has shown promise – but just in mice, so remember it’s still early days.

A few other things to keep in mind: First, it’s not immortality that scientists are after -- people don’t want to live forever, but rather to be healthier for longer. Second, the FDA is a long way from being able to assess anti-aging therapies because it still views aging as a natural process. In contrast, the World Health Organization recently declared aging a treatable condition. Finally, there’s a lot of hype that makes it hard to separate fact from fiction. David Sinclair said that one of his challenges has been removing his face -- and Harvard’s name -- from websites for anti-aging products that he has nothing to do with and would never endorse.

Let’s Look at This Straight in the Eye...

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In conversations on Value Investing, references to the 1962 New York Mets have been coming up more often, and that’s not a good thing. The 1962 Mets are beloved for losing a staggering 120 games -- a record for the history books that spurred then-manager Casey Stengel to despair, “Can’t anybody here play this game?”

Value Investing too is on a losing streak. The common wisdom has been that Value Investing outperforms its rival Growth Investing over the long run, but over shorter periods, Growth and Value take turns doing better than the other. The problem for Value today is that it has been waiting an awfully long time for its turn, while Growth’s dominance has been impossible to ignore.

So full disclosure: We are Value Investors. We’ve always believed in buying the stocks of unpopular companies that look cheap and then staying patient until prices revert to fair value. Likewise, we have shunned the excitement of fast-moving companies and the high prices Growth Investors are willing to pay for them.

Put another way, we believe in reversion to the mean: The popular eventually become less popular and vice versa. But today we find ourselves in a world where go-go growth stocks like Amazon and Alphabet just keep going, and the downtrodden can’t seem to get a leg up in the world.

The thing about a losing streak is that you never know when it will end – or if it will -- and the longer it goes on, the more you wonder. But as Value Investors, we can’t shrink away from this. We have to look at this squarely in the eye. So what are we thinking?

First, we still firmly believe in the core principle of Value Investing, which is simply buying things when they are cheap or priced below fair value. That’s intuitive. Have you ever heard Warren Buffett’s partner Charlie Munger say, “All good investing is Value Investing, by definition”? There you have it. Investing is about what you pay for what you get, and that’s straightforward.

The struggle today is in looking at fair value the right way. We know we’re not living in the world of Benjamin Graham, the father of Value Investing who noticed that stock prices fluctuated a lot more than the value of a company’s underlying assets. Graham focused a lot on the value of a company’s assets, especially its tangible assets like factories, machinery, trucks and railcars. And while we have long done the same, we also recognize that today we’re in a world where intangibles like technology and intellectual property matter a lot.

The biggest companies today are not GM or GE. They are Microsoft, Apple, Amazon, and Facebook. Airlines and steel companies are one thing. Software or entertainment companies are another, and it’s a different game to think about what intangible assets are worth and how they turn into future cash flows. That doesn’t mean that valuation principles go out the window, but it does make the work harder. We’ve never been a fan of looking at ratios or multiples alone because investing has never been as easy as simple metrics. But today more than ever, we spend more time thinking about earnings quality and competitive position and where a company sits if its industry is being disrupted.

We also have to acknowledge that mean reversion may be a long time coming for some companies that enjoy powerful network effects. Network effects are where businesses become more valuable and powerful as more people join their ecosystems. For example, the more people that join Facebook, the more that others want to join, and the more market share Facebook can take. Or the more people that join Amazon Prime, the easier it is to spread the costs and invest in even more member benefits, which attracts more people. These situations give rise to a “winner take all” environment where winners keep winning and recovery gets harder for those who fall behind.

Nothing lasts forever and things can’t keep growing to the sky. Gravity still exists. But we also recognize there can be long-lasting value in a company’s network effects even if its price-to-earnings multiple looks high.

In sum, we think Value Investing has legs because Value Investors have been adapting to a changing world since Ben Graham first wrote Security Analysis in 1934, and they will continue to do so. Warren Buffett can buy Amazon stock, and the principle of separating price from value endures.

Why Selling Seems Harder Than Buying...

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Why is it that selling a stock can seem so much harder than buying? We admit that we feel that way, and we suspect many other investors do too.

Rationally, it doesn’t make any sense because the process behind buying and selling are the same – two sides of the same coin, so to speak. But a recent working paper called “Selling Fast and Buying Slow” (Akepanidtaworn, Di Mascio, Imas, and Schmidt, 2018) confirms what many investors have long thought: Buying stocks is easy, but selling them is hard.

After looking at 783 portfolios and 4.4 million trades to analyze the performance of buys and sells separately, the paper found that portfolio managers display clear skill in buying, but not in selling. In fact, investor selling decisions are so poor that they underperform a no-skill strategy of randomly selecting stocks for sale -- say, by throwing darts at a dartboard.

That’s a striking result. How could it be that a skilled buyer isn’t automatically a skilled seller when buying and selling are analytically similar? If your practice is to analyze financial fundamentals and buy what is undervalued, then it seems that if you use the same fundamentals to sell what looks overvalued, you should achieve symmetrical results. And yet often it isn’t so.

One possible reason for this is that buying and selling are different exercises psychologically. According to the paper, portfolio managers rely heavily on a stock’s past return when making a sell decision -- but they do not do so when buying a new stock. For some reason, when considering a sale, past return becomes the most readily available piece of information that an investor reaches for. So while buying always is forward-looking, selling becomes backwards-looking.

That is something that’s likely to ring true for many of us. When you look anew at a stock that has dropped 20%, you tend to focus not on the price drop but on the fundamentals. But it’s a different story when you already own the stock. Suddenly, that 20% price decline makes the decision to sell, hold or add more difficult.

There are a few other interesting things here too: First, selling happens most often for stocks with extreme returns, either positive or negative, and that is often to the detriment of performance. The best and worst performing stocks get sold at a rate 50% higher than those with moderate returns -- and the portfolio managers with the greatest propensity to sell extreme-return stocks have the worst selling outcomes.

Next, selling decisions seem to be especially poor when investors are stretched or under duress because when things are going badly for the portfolio as a whole, sell decisions get worse even though buy decisions don’t.

And finally, it doesn’t appear that portfolio managers lack the fundamental skills to make good selling decisions. However, it is clear that they spend much more time thinking about buying than selling. Perhaps that is because they think their main job is to find the next great idea. Or perhaps buying is just more psychologically satisfying than selling. When you buy, the idea is fresh and optimism abounds. When you sell, you’ve already gotten mired in your own experience.

The good news is that when investors spend the time to think more about selling, they are able to port their fundamental skills over and achieve better selling outcomes. So one lesson here is simple: Just pay more attention to selling.

Another lesson is to think twice and then thrice before selling anything that has had either extremely good or terrible performance because the chances of making a mistake are especially high.

And finally, investors should find ways to keep looking forward instead of backwards when assessing stocks for sale. A recent Bloomberg Businessweek article noted that one fund takes away coverage from the original portfolio manager after a stock has had two straight quarters of earnings disappointments. That’s one interesting strategy to keep a fresh, forward-looking perspective on an underperforming stock.

Quality Matters...

Between 1976 and 2017, Warren Buffett’s Berkshire Hathaway delivered an average annual return of 18.6% over Treasury bill rates -- easily beating the stock market’s excess return of 7.5%. That is not just a good run for a few years or a decade. It’s an extraordinary record spanning four decades. On a risk-adjusted basis, Berkshire has outperformed any mutual fund or single stock that has a 40-year history. As a paper called “Buffett’s Alpha” puts it, “If you could travel back in time and pick one stock in 1976, Berkshire would be your pick.”

The purpose of that paper -- first drafted by Andrea Frazzini, David Kabiller, and Lasse Heje Pedersen in 2013 and revised last month – isn’t to gush over Buffett’s record. It’s to ask how and why it was possible. Taking a hard, empirical look, it finds two big things that explain Buffett’s success.

One is that Buffett had unique access to cheap leverage, or borrowed capital, because his insurance companies could hold premiums collected upfront until claims needed to be paid out. That constitutes a form of cheap financing that isn’t available to most investors. The second element, which is widely accessible, lies in the kinds of stocks that Buffett chose to buy -- cheap, safe, and high-quality.

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We know that buying cheap leads to better investment results – there is a mountain of evidence on this. But according to the paper, what really sets Buffett apart is his practice of buying “safety” and “quality.” Safety refers to stocks with relative price stability. But what about “quality?” What exactly is it? Quality can seem like a murky concept.

A 2013 paper called “Quality Minus Junk” (Asness, Frazzini, and Pederson) defined quality as something investors should be willing to pay a higher price for. It further characterized quality as having four dimensions. First is profitability, as measured by earnings, cash flows, margins or other metrics. Second is a record of growth. Third is safety – both in terms of stock price stability and fundamental factors like low debt or credit risk. And fourth is the profit that companies pay out (dividends), which is a measure of shareholder friendliness.

The paper found that when quality stocks are defined in this way, they do generate higher excess returns. They also command a higher price – though not as high as you would expect given their excess returns. That suggests that quality is “underpriced” by the market. And interestingly, quality is persistent -- meaning that the quality companies of today tend to remain quality firms five and ten years into the future.

Of course quality is in some ways the opposite of cheap – so how does quality work for value investors, who like cheap? Well, first, remember that quality might generally be underpriced by the market. And second, the paper suggests that combining quality considerations with value leads to better results than value alone.

Finally, keep in mind that the price of quality changes over time. The 2013 paper found that the price of quality reached its lowest level at the height of the dot-com boom in February 2000. It also was cheap before the 1987 crash and the 2008-2009 financial crisis. But after these events, the price of quality rose, reaching highs in late 1990, 2002, and early 2009. So perhaps the lesson here is to buy quality when it gets cheap during boom times -- not when everyone is rushing for the exits.

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