Super-investor Jeremy Grantham was recently interviewed on Pat O’Shaughnessy’s “Invest Like the Best” podcast.
He sums up the decline of traditional quant value in quite possibly the most succinct way I have heard or read. The fact that this is also coming from an investor who started investing before most investors today were even born gives him credit, in my books at least.
(Podcast episode and transcript here:
http://investorfieldguide.com/jeremy-grantham-an-uncertain-crisis-invest-like-the-best-ep-177/ )
Transcript Excerpt:
We were lucky when we came in, in that some [value] parameters that somewhat reflected a value had worked
pretty well as contrarian indicators for 80 years or so when we started 40, 50 years ago. And those were
things like price to book, PE, price to cash flow, price to sales. What I have long thought of as dopey
value. What they are really is just expressions of the market’s disgust and the cheapest price to book
are really the assets, which dollar for dollar, the market thinks are the least useful. And the lowest PE
are the earnings the market least believes will be sustainable and the highest yield are the most likely to
be cut or not sustained.
Jeremy Grantham:
There’s no reason why those things should work and indeed for 20 years now, they haven’t been
working. But in the old days they worked because the market loved comfort so much that it was
constantly overpaying a little bit for the Proctor and Gambles and underpaying for those nasty cyclicals
that kept getting excess production and getting crushed. And we came in, my first firm, I started in 1969
and we applied those standard Graham and Dodd techniques. And they worked beautifully. Life was
simple. They didn’t work every year. And you occasionally had a string, a painful string, of two, three or
even four years where growth stocks were trash and upset your clients.
But they came back, made up for the lost ground. And so if they gave up four points one year, they
would make it back and deliver the usual four points a year the following year. And so life was easy. And
I think the general caliber of competition back in those days was very weak. And therefore, if you did
decent analysis and looked for value, you could find it.
Jeremy Grantham:
So we were able to build simple mechanistic models, giving points for cheap book and so on and have a
win on a very broad basis. So we could manage a lot of money. And we were winning two out of three
years and adding a few points on average a year. And that era perhaps started to end around 2000 and
too many machines were picking it up; too many quants, too much money.
Jeremy Grantham:
And pretty soon the historical aversion to cheap stocks had disappeared because they acquired the
reputation for having won. The quants made it clear. They understood that for 80, 100 years into the
midst of time, these were factors that worked. And indeed academics wrote it up and got a lot of credit
for it, such as simple minded idea.
Jeremy Grantham:
And anyway, that was the past. And those early pickings have gone leaving, as I said, old fashioned labor
intensive, stock by stock analysis; not only labor intensive, but risk intensive, because you have to bet
that the things will change and you have to bet that the market is wrong. And that gives a lot of people,
not surprisingly a lot of trouble.