Looking Back at James Montier's "Perfect" Value Investors
Is there such a thing as a “perfect” value investor? And if so, what does that investor’s fund look like?
James Montier thought he knew the answers when he penned his 2006 article “The Perfect Value Investor.” At the time, Montier was the director of global strategy at Dresdner Kleinwort Wasserstein, a London-based investment bank. He is now at Boston-based Grantham Mayo van Otterloo (GMO).
As Montier noted, Bob Goldfarb, chief executive of the legendary Sequoia Fund, was asked by Columbia University professor Louis Lowenstein “to select ten dyed-in-the-wool value investors who all followed the essential edicts of Graham and Dodd.”
Goldfarb came up with nine. His final list of “tried and tested” value funds was as follows: Clipper, FPA Capital, First Eagle Gold, Legg Mason Value, Longleaf Partners, Mutual Beacon, Oakmark Select, Oak Value and Tweedy Browne American Value. In 2006, this fund’s name was changed to Tweedy Browne Value.
By way of background, Goldfarb and the Sequoia Fund were included among “The Superinvestors of Graham-and-Doddsville” that Warren Buffett identified in a 1984 talk. An endorsement from Warren Buffett is a pretty hefty credential in anyone’s book.
Characteristic behaviors of the best value investors
Montier used Goldfarb’s list to identify these six traits of “some of the best value investors:”
Highly concentrated portfolios.
No need to know everything and the ability to avoid getting caught up in the noise.
A willingness to hold cash.
Long time horizons.
An acceptance of bad years.
Preparedness to close funds.
Of these six common traits, passively managed value funds possess three:
They have long horizons.
They don’t need to know everything and don’t get caught up in the noise.
They accept bad years.
That leaves three traits that passively managed value funds don’t have in common with Goldfarb’s “great value managers.” Unlike the “great value managers,” passively managed funds don’t concentrate portfolios. Instead, they broadly diversify. One of the major tenets of modern portfolio theory is that diversification reduces risk without reducing expected returns. Thus, broad diversification is a good trait. According to the Uniform Prudent Investor Act, “Because broad diversification is fundamental to the concept of risk management, it is incorporated into the definition of prudent investing.”
Passively managed funds also don’t hold cash, another trait Montier identified as common among the “best” value investors. Russ Wermers – author of the 2000 study “Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transaction Costs, and Expenses” – found that non-equity holdings reduced returns for the average actively managed equity fund by about 70 basis points per year. In addition, as an actively managed fund increases its holding of cash, investors lose control over their asset allocation, which determines the majority of risk and expected return of a portfolio.
The last of the three traits that Montier attributed to great value investors not found in passively managed funds is the need to close to new investors. Such a need is unlikely to impact passively managed funds, especially funds focused on large-cap stocks, because they don’t concentrate portfolios. Thus, they don’t face the type of market impact costs that active funds can incur when trading large positions.