Nobel prize returns
The Stockholm stock exchange is phenomenal, and value investing is better. So what’s the problem? Well, lots of investors are far too impatient, according to new research.
In the past 50 years, the Stockholm stock exchange has risen by an average of 9.4 percent per year. It’s the best in the world.
“Were a Nobel prize to be awarded for investment returns, it would be given to Sweden for its achievement as the only country to have real returns for equities, bonds and bills all ranked in the top five,” writes Credit Suisse in its comprehensive analysis in the Global Investment Returns Yearbook 2016, published in February 2017.
|Annualized real returns on
equies in USD, 1967-2016.
Credit Suisse looked at all the stock exchanges with available long-term data and compared their total return (share price gains with dividends reinvested) in USD.
The bank found that Sweden is the only country ranked top-five not only for equities but also for government bonds and treasury bills. Some historical factors explaining this success are Sweden’s commodity assets and the emergence of investment companies.
Credit Suisse also notes that Sweden is top-rated for sustainability, which indicates a long-term attitude and planning.
Sweden’s Nordic neighbours also stand up well in a 50-year perspective. Finland, Denmark and Norway have all outperformed the global average1 – and Carnegie Strategifond invests in all of them, as well as in Sweden.
Credit Suisse has therefore mapped out the index performance, which in investment fund circles is known as passive management. The opposite of passive management is, of course, active management, which means that the portfolio manager ignores the index and instead invests only in companies that appear to be attractively valued.
The danger of this is clearly that the performance might not be as good as the index, but it also creates the potential for better performance. Or as legendary fund manager Sir John Templeton said, “If you want to have a better performance than the crowd, you must do things differently from the crowd.”
Templeton was hugely successful. He was a pioneer of fund management and delivered solid returns to his unitholders for several decades. He himself became a multi-billionaire, and after giving most of his wealth to charity he was knighted.
Sir John Templeton’s recipe for success was active management, or more specifically value investing. His strategy was to avoid the flow and instead seek out ignored and “dull” companies that were undervalued. And to be long-term. The opposite of value investing is growth investing, which involves investing in faster-growing and often popular stocks.
The success of value investing has been proven any number of times, and not just by legends like Sir John Templeton, Warren Buffett and Benjamin Graham.
Value beats ‘em all
In his book What Works on Wall Street, portfolio manager James O’Shaughnessy observed that anyone who invested 10,000 dollars in US stocks with high P/E ratios in 1950, and in each subsequent year, would have had a portfolio worth 793,558 dollars by the early 2000s. Not bad – but investing the same amount each year in companies with low P/E ratios (a sign of value stocks) would have generated 8,189,182 dollars. More than ten times as much.
The superiority of value investing is also confirmed by Chicago professors Eugene Fama (who won the 2013 Nobel Memorial Prize in Economics) and Kenneth French. In short, they made two observations: Value stocks perform better than growth stocks over time, and small cap stocks perform better than large cap stocks over time.
The same is evidenced in a recent study published in The Journal of Portfolio Management, examining the returns on various types of equity funds in 1991–2013: Value beats growth and small cap beats large cap, according to the authors.
In fact, the superiority of value investing is so well established that it is strange the phenomenon persists. Because if we can be so certain that value stocks are the best, why don’t all investors buy value stocks? The answer, according to the co-author of the study, Jason Hsu, is: We fund investors are too short-term and have too little patience.
Jason Hsu and his colleagues studied not just the outcomes for fund managers, but also for fund investors. There should be no difference, and for long-term investors there isn’t. But an analysis of fund flows (that is, how investors have bought and sold their holdings) shows something interesting: Instead of using a long-term buy-and-hold strategy, lots of investors try to time their investments and jump from one fund to another.
Some succeed, but the vast majority get it wrong. Really wrong, according to Jason Hsu: Over the past 20 years, fund investors have lost 2 percent per year by trying to work the timing. Quite simply, lots of investors try to buy funds that have already gone up, and sell funds that have already gone down, which explains the title of the study, Timing poorly: A guide to generating poor returns while investing in successful strategies.
So how should investors behave? There are two strategies, according to Jason Hsu. One is to do the opposite, to buy funds that have fallen and sell those that have risen. The other is much simpler: to be long-term.
Embracing the declines
In fact, it’s the bad deals done by the jumpers that make the good returns possible for long-term investors. When one person sells another person buys, and when one person sells cheaply someone else buys cheaply. According to Jason Hsu, it is likely that this lack of patience, or trying to time the market, that makes value investing so successful time and time again.
The fact that share price falls are actually a positive thing for long-term value investors is also shown by John Strömgren, who manages Carnegie Strategifond. He writes on carnegiefonder.se:
“Experience has taught us that stock prices go up and down. For the long-term investor, a decline creates opportunities for higher returns. Carnegie Strategifond invests primarily in equities that provide a good dividend and therefore benefits from lower share prices. As a ballpark figure, this means that the fund’s return increases by 1 percent annually. The long-term investor in Carnegie Strategifond can therefore welcome a stock market fall.”
These studies might be some comfort to value investors who are starting to run out of courage. Because in recent years many value stocks have been overtaken by faster-growing alternatives. This has been particularly pronounced in the United States, where companies like Facebook, Amazon, Netflix and Google (together referred to as “FANG” in the financial world) have beaten value stocks like Boeing and Goldman Sachs by a mile. Swedish fast growers that have been popular lately include Assa Abloy, Hexagon and Fingerprint Cards.
There are those who believe that value stocks are facing a comeback. They say quite simply, just like Jason Hsu, that the market moves in cycles and that value usually comes to the fore after strong periods for growth stocks. The years between the dotcom crash in 2000 and the financial crash of 2008 are the most recent example.
Financial journalist John Authers at the Financial Times notes that value investments work best when everything is either terrific or terrifying, “A long drawn-out rally with low rates, with little conviction but little fear, is about as dreadful a scenario for value as it is possible to imagine. Once the cycle turns in value’s favour, the style should outperform handsomely.”
But, as we know, timing is the difficulty and it is probably safest to be long-term. Warren Buffett is famous for buying only companies that he likes. He believes that forever is the best investment horizon, and he sees no problem with a stock exchange that is only open for trade on one day a year. Or as Sir John Templeton expressed it, “Buy stocks for less than they are worth and hold them – as long as it takes for the market to appreciate how undervalued they are.”
And why not do that on the world’s best stock market?