The dozen or so year-end letters to investors I’ve read so far suggest that the clouds finally are parting for value investors. There is a positive tone in the letters that contrasts sharply with early 2016.
Value investors buy undervalued out-of-favor securities based on careful fundamental research. An important part of that practice is being patient and outlasting difficult stretches of time where undervalued securities stay undervalued. But this can be very hard. Until recently, value investing has tested even the most patient of investors.
Even legendary value investor Seth Klarman, who rarely has a bad year, wrote a year ago that “bottom-up bargain hunting – which requires fastidious research, endless patience, pattern-recognition skills derived from hard-won experience, and the application of sound judgment – didn’t prove profitable for us last year.”
Other letters last year earnestly tried addressing all possible reasons for things going wrong – has something fundamentally changed, have we been fooled all these years. . . are we just dumb?
This year’s letters are different. Many devote space to thoughts on the Trump administration, which is surely a big change worth thinking about. But another recurring message is that what wasn’t working just a short while ago is now working very well. Longleaf Partners writes:
This time last year, the energy and gaming investments in the Funds were a source of disappointment, even though we felt that our management partners were making smart moves . . . Their industries now have tailwinds, as commodity prices have returned to more reasonable, yet still low, levels, and Macau gaming has shown early signs of renewed growth. This group is now on offense . . .
Another theme is that active management is resurgent. In recent years, few things in the mainstream press have enjoyed such near universal consensus as passive investment’s superiority. The widespread narrative has been that because active management adds no value whatsoever, passive investment’s march toward world domination is inevitable. But now there has been a shift in the winds. First Eagle Investment Management notes:
This is an era for active management. Passive management may have been reasonably productive in the early 1980s when P/E multiples were low, bond yields were high, and investors could produce a decent return by just showing up. We think today’s markets call for a much more thoughtful approach – identifying and avoiding securities that are not priced rationally . . .
And Longleaf adds:
The shift to indexing had been a headwind for the Funds for several years because it drove stocks to move in lockstep and favored momentum investing, as indexing is a strategy that buys more of what has been going up. Even though indexing remains in favor, 2016, and the second half of the year in particular, saw positive signs that this force is abating . . .
We will see what really happens. In any case, value investors are used to not being loved. As Seth Klarman put it last year, “You don’t become a value investor for the group hugs.” But this year, maybe value investors will be liked just a little bit.