Following Rational Investors Through The Perfect

Following Rational Investors Through The Perfect
Storm
Apr/2016
Dr. Vikas V Gupta
Ashwini Shami
Varun Sood
Viraj Vajratkar
Vishap Rana
Can Smart Value Investing Beat The Legends of Value Investing?
In his article, “Searching for Rational Investors In a Perfect Storm”i, Louis Lowenstein, talks about the efficient market
theory and its so-called rational investors. He proposes that the “Rational Investors” of the academic theory are the
“Value Investors”. He got a list of 10 value funds from Sequoia fund’s Robert Goldfarb, the Goldfarb 10. The fund
managers of these 10 funds are the Intelligent Investors or Smart Investors who know the basic principles of investing
and invest rationally.
His investigation of how they performed during the perfect storm of 1999-2003 is what the Lowenstein article is about.
It was open to a few criticisms that Seth Klarman highlighted in another article “A Response to Lowenstein’s Searching
for Rational Investors In a Perfect Storm”ii. Seth Klarman suggests that an ex ante list of the fund managers would have
been good.
Now we have had another perfect storm and that is not over yet. This storm started becoming visible in 2007 and is
still going on. We also have an ex ante list of the fund managers as Seth Klarman suggests. We examine the same set
of 10 funds, i.e. the Goldfarb 10 plus a few more (we call them as “Value Masters”) which are acknowledged as value
funds by most of the industry. We have added Sequoia Fund of Goldfarb, which Lowenstein ideally wanted to add, and
Buffett’s Berkshire and Greenblatt’s Gotham fund. We trace their performance through the new perfect storm and
see how they fare. Further, Oak Value Fund (OAKVX) was acquired in 2010 so we no longer keep it in the Value Masters
list.
There have been only 2 studies, that we know of, of actual practicing value investors in the literature and these are
the articles by Warren Buffett in 1984, ”The Superinvestors of Graham-and-Doddsville”iii, the Buffett 9 and by Louis
Lowenstein in 2004, “Searching for Rational Investors In a Perfect Storm”, the Goldfarb 10. These were 20 years apart.
”Will we have to wait another 20 years for a study of rational, value investing?” wonders Lowenstein. Not anymore.
We aim to make the studies a little bit more frequent by pitching a study after about 10-12 years instead of waiting
for the usual 20 years. Presenting the Value Masters.
The questions which Lowenstein raises are:






Are there rational investors out there?
Did they achieve results different from the market?
Did they outperform the markets significantly?
Can we still assume the markets are efficient?
Do they hold a concentrated or diversified portfolio?
Do they buy and hold or trade frequently?
We will answer these questions after presenting some observations based on the performance of the Value Masters’
funds from 2003 to 2015.
This study is neither an endorsement nor a critique of the methods of these fund managers. The idea is to trace their
performance through another of the perfect storms which, if the efficient market theory is fully true, should not
occur at all. Please see page 18-19 for important disclaimer and disclosure information.
2
Value Masters Performance in the New Perfect Storm: 20032015
The funds and strategy indices under the study are given below:
Fund/Index name
Berkshire Hathaway
Clipper Fund
Fairholme Fund
First Eagle Global Fund Class A
First Eagle Global Fund Class C
FPA Capital Fund
Franklin Mutual Beacon Fund Z
Gotham Absolute Return Fund
Legg Mason Opportunity Trust Class C
Longleaf Partners Fund
Oakmark Select Fund Class I
Sequoia Fund
Source Capital
SPDR S&P 500 ETF
SPDR S&P 500 Growth ETF
SPDR S&P 500 Value ETF
Tweedy Browne Value Fund
ArthVeda US Large-Cap 500 Value
ArthVeda US Total-Cap 50 Extreme
ArthVeda US Total-Cap 50 Income
Ticker
Berkshire
CFIMX
FAIRX
SGENX
FESGX
FPPTX
BEGRX
GARIX
LMOPX
LLPFX
OAKLX
SEQUX
SOR
SPY
SPYG
SPYV
TWEBX
AULU
AUTX
AUTD
In the 1999 to 2003 study of Lowenstein the Value Masters together (i.e. average performance of Goldfarb’s 10)
outperformed the markets represented by S&P500 by nearly 10 to 12% per annum. Ex ante, one would definitely
expect a significant outperformance in this new study. Let us see what actually happened.
First, we have compared the total returns of these value masters vs. the markets since 2003 and sliced it across
different time periods. Figure 1 show the performance of the value masters vs. the market index tracking ETFs (SPDR
S&P 500 ETF SPY, SPDR S&P 500 Value ETF SPYV, SPDR S&P 500 Growth SPYG) on total return basis.
It is difficult to decipher from the chart shown in Figure 1 whether the Value Masters outperform. Yes, some seem to
be ahead of the markets but it is not as distinct as expected. One would have expected the Value Masters to beat the
market indexes hands down. But the figure shows that the market’s performance as represented by the ETFs is
somewhere in between the Value Masters. It seems difficult to say that all of the Value Masters ourperformed the
markets. Rather, the performance of the Value Masters compared to the Markets seems about average. Some are
ahead and some are behind or around the market performance.
We further look at Table 1 below which shows the returns over the full period (start of 2003 to end of 2015) for all the
funds. It shows that the average return for the 13 Value Masters (except GARIX which did not exist for the full period)
is 7.8% and the market return (SPY) was of 8.5%, an underperformance of 0.7%.
3
Comparison of Value Masters with the market
Figure 1
Value Masters vs. Markets
(since 2003)
500
400
300
200
100
0
2003
2003
GARIX
SGENX
TWEBX
2004
2005
2006
2007
FAIRX
FESGX
SEQUX
2008
2009
2010
2011
LLPFX
BEGRX
SPY
2012
CFIMX
OAKLX
SPYV
2013
2014
2014
2015
FPPTX
LMOPX
SPYG
Source: Thomson Reuters, Black lines indicate S&P 500 based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF (SPYV), SPDR S&P 500
Growth (SPYG); these are based on total returns index; rebased to 100; data from 03-Jan-2003 to 31-Dec-2015
Table 1
Annualised returns since 2003
BEGRX
7.6%
Berkshire
8.1%
CFIMX
5.4%
FAIRX
9.0%
FESGX
9.5%
FPPTX
7.5%
LLPFX
5.8%
LMOPX
8.0%
OAKLX
8.6%
SEQUX
7.9%
SGENX
10.2%
Source Capital
8.0%
TWEBX
6.5%
Average (13 funds)
7.8%
SPY
8.5%
Underperformance
-0.7%
Source: Thomson Reuters; these are total returns
If this was a study of all so-called “Value” mutual funds and they performed in line with the markets with a few of
them ahead it would not be surprising. But the fact that we have restricted our study to the Value Masters who had
outperformed by leaps and bounds in an earlier “Perfect Storm” makes the average performance quite unexpected.
4
Performance during the calm…
Let us focus on the initial period before the storm. Figure 2 shows the performance during the period 2003 to 2007,
just before the storm started.
Even during this period there doesn’t seem to be a clear outperformance of all the Value Masters vis-à-vis the markets.
They seem to be performing broadly around the market performance. Table 2 shows the returns of Value Masters vs.
markets. Again unexpected would be a mild way of putting that. While the Value Masters portfolio as a whole
outperforms SPY by 1.7%, nearly half, i.e. 6 Value Masters lag SPY. So, the expectation that all Value Masters would
beat SPY hands-down is not met.
Figure 2
Value Masters vs. Markets
(before recession)
300
250
200
150
100
50
0
2003
2004
GARIX
SGENX
TWEBX
FAIRX
FESGX
SEQUX
2005
LLPFX
BEGRX
SPY
2006
CFIMX
OAKLX
SPYV
2007
FPPTX
LMOPX
SPYG
Source: Thomson Reuters, Black lines indicate S&P 500 based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF (SPYV), SPDR S&P 500
Growth (SPYG); these are based on total returns index; rebased to 100
Table 2
Annualized returns 2003-2007
LMOPX
24.7%
SGENX
21.8%
FESGX
20.9%
FAIRX
20.6%
BEGRX
18.8%
FPPTX
18.5%
LLPFX
16.3%
OAKLX
13.9%
Source Capital
12.8%
TWEBX
12.4%
Berkshire
10.0%
SEQUX
9.8%
CFIMX
9.1%
Average (13 funds)
16.1%
SPY
14.4%
Outperformance
1.7%
5
Source: Thomson Reuters; these are total returns; data from 03-Jan-2003 to 31-05-2007
Figure 3 shows the calendar year rank positions for the Value Masters and the market index ETFs. It shows that while
in the pre-crisis period more of the funds outperformed the index ETFs, but by no means all, in the post-crisis period
fewer funds outperformed. 10 out of 13 times at least one of SPY/SPYG/SPYV has been in the top half in terms of
performance (of the total 17 funds including SPY, SPYG, SPYV under study) since 2003 (the period under consideration
is 2003-2015). Considering the investing acumen of the Value Masters, one would expect the markets to be always at
the bottom position in terms of performance when compared to Value Masters. But the results suggest otherwise.
Value Masters through the Calm and the Storm…
Figure 3 - Performance rank of Value Masters vs. Markets – All years
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
LMOPX
Source Capital
FPPTX
Berkshire
Berkshire
SGENX
LMOPX
Source Capital
SEQUX
LMOPX
LMOPX
Berkshire
CFIMX
SGENX
FAIRX
SGENX
LLPFX
FAIRX
FESGX
Source Capital
FAIRX
SPYG
FAIRX
OAKLX
OAKLX
SPYG
FPPTX
SGENX
FESGX
SPYV
SPYG
TWEBX
FPPTX
FPPTX
CFIMX
OAKLX
FAIRX
SPYG
SPY
FESGX
FESGX
FAIRX
BEGRX
FESGX
SEQUX
LLPFX
Berkshire
OAKLX
Source Capital Source Capital
SPY
LMOPX
LLPFX
BEGRX
Source Capital
SGENX
SEQUX
FAIRX
OAKLX
SEQUX
SPY
SPYV
CFIMX
Source Capital
SGENX
BEGRX
LMOPX
BEGRX
FESGX
SGENX
Berkshire
FAIRX
LLPFX
FPPTX
Berkshire
Berkshire
SPYV
FESGX
OAKLX
SPYV
SEQUX
FAIRX
SPY
FPPTX
CFIMX
SGENX
SGENX
LLPFX
SPYG
LMOPX
Source Capital
SPYG
TWEBX
LMOPX
SPY
BEGRX
OAKLX
SPYG
FESGX
SPYV
BEGRX
SEQUX
GARIX
SPYV
SPY
FPPTX
SPYV
CFIMX
SPYV
SPYV
BEGRX
LMOPX
FESGX
SPY
SPY
SEQUX
OAKLX
FAIRX
SPY
OAKLX
OAKLX
TWEBX
SPY
TWEBX
SPYG
TWEBX
SEQUX
LLPFX
CFIMX
BEGRX
SPYV
OAKLX
SPY
LMOPX
CFIMX
SPYG
SPY
SPYV
BEGRX
TWEBX
SPYV
BEGRX
TWEBX
TWEBX
LLPFX
LLPFX
TWEBX
FPPTX
BEGRX
SGENX
SPY
LLPFX
SPYG
GARIX
LLPFX
SEQUX
Berkshire
CFIMX
SPYG
SPYG
LLPFX
LLPFX
FESGX
CFIMX
Berkshire
CFIMX
BEGRX
TWEBX
GARIX
SEQUX
SPYG
TWEBX
SEQUX
LMOPX
Source Capital
SPYV
OAKLX
Source Capital
SGENX
FPPTX
SGENX
FAIRX
CFIMX
SEQUX
Berkshire
FPPTX
Source Capital
CFIMX
SEQUX
BEGRX
FAIRX
FPPTX
TWEBX
FESGX
Berkshire
Source Capital Berkshire
CFIMX
Source Capital
OAKLX
LMOPX
Berkshire
TWEBX
LMOPX
FESGX
SGENX
FPPTX
FPPTX
FESGX
FAIRX
LLPFX
Source: Thomson Reuters, ArthVeda Capital; Red colours represent S&P 500 based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF
(SPYV), SPDR S&P 500 Growth (SPYG); these are based on total returns; performance of GARIX not available before 2013; data from 03-Jan-2003
to 31-Dec-2015
Figure 4 tries to focus only on the long-term performance of 3, 5, 10 years and since 2003. This too is showing a
performance which mostly lags the market index ETFs. The market performance is even better and consistent with
SPY/SPYG/SPYV among the top 3 performing funds in the last 3 years, 5 years, 10 years and since 2003.
6
Performance during longer periods…
Figure 4 - Performance rank of Value Masters vs. Markets – Long periods
3 Yr
5 Yr
10 Yr
Since 2003
LMOPX
SPYG
SPYG
SGENX
SPYG
OAKLX
Berkshire
FESGX
CFIMX
SPY
SEQUX
SPYG
SPY
CFIMX
OAKLX
FAIRX
OAKLX
SEQUX
SPY
OAKLX
Source Capital Source Capital
SGENX
SPY
Berkshire
SPYV
FESGX
Berkshire
SPYV
LMOPX
SPYV
LMOPX
BEGRX
Berkshire
FAIRX
Source Capital
SEQUX
BEGRX
Source Capital
SEQUX
GARIX
TWEBX
TWEBX
BEGRX
TWEBX
SGENX
CFIMX
SPYV
SGENX
LLPFX
BEGRX
FPPTX
FAIRX
FESGX
FPPTX
TWEBX
FESGX
FPPTX
LLPFX
LLPFX
LLPFX
FAIRX
LMOPX
CFIMX
FPPTX
Source: Thomson Reuters, ArthVeda Capital; Red colours represent S&P 500 based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF
(SPYV), SPDR S&P 500 Growth (SPYG); these are based on total returns; performance of GARIX not available before 2013; data as of 31-Dec-2015
It is Really Stormy
So what accounts for such a vast underperformance of majority of the value masters’ funds? Was it a bad time for the
Value style as many market practitioners and the academicians are wont to say? Possibly, in hindsight, it was a time
for the Growth style? The top performance of SPYG does seem to indicate that.
But these are not the average value investors we are talking about, we are talking about the Value Masters mostly
handpicked by one of them, i.e. Goldfarb. These investors have a much more sophisticated investment style and
definitely understand and practice the more sophisticated style of value investing which is buying at a discount to
intrinsic value. This style allows buying companies which are so-called growth companies when they are available
below their intrinsic value. It is a significantly different style of value investing as opposed to a low price-to-book or
low price-to-earnings approach which is the classical value investing as understood by academics.
In any case, it seems that even the Value Masters are facing difficulty outperforming the markets.
Is there a better way? Value Investing the Next Generation
Let us take a step back and understand the context in which the investment ecosystem has been evolving for the last
decade or so. In the last decade, the mutual funds have been losing hundreds of billions to index tracking funds and
ETFs. This is an admission that it is difficult to find active fund managers who can outperform the markets. Another
trend within this trend is of sticking to rules-based investing strategies, i.e. indexing but with a twist. This twist is the
7
non-market-cap weighted indexes which are called Smart Beta indexes popularly, but Strategic Beta, Alternative Beta
and Factor indexes are other names used for these.
The emergence of Smart Beta demonstrates the acceptance of two facts:


One, that there is a possibility of beating the markets. To us this is an admission that there is some inefficiency
in the markets. Of course, the practitioners justify it by saying Smart Beta is higher returns as a compensation
for taking higher risks.
Second, that the rules-based strategy is a better way of investing than human fund managers, even
professionals, who are prone to human behavioural errors.
Based on the above, our starting axioms are:




Markets are inefficient to some degree. Inefficiency to us being the existence of stocks at market prices which
are significantly different, i.e. either higher or lower, than their intrinsic value. In short, Mr. Market misprices
some stocks from time to time.
Thus value investing, which is buying below intrinsic value and selling above intrinsic value with a significant
margin of safety, works.
A rules-based investing strategy which removes the possibility of the human behavioural errors which even
the Value Masters might be prone to is desirable.
A rules-based investing strategy whose rules are based on the value investing principles would be a robust
approach to investing based on the right way of doing things, i.e. embodying a margin of safety and buying at
a discount to intrinsic value for a long-term exposure to equities.
Smart Alpha Framework: A Structured Approach to Value Investing
With the above axioms and value investing principles, we have developed an approach called the Smart Alpha
Framework. This umbrella concept includes 3 variants, viz. Smart Alpha, Smart Value and Smart Income.
Smart Value is designed to provide a core exposure to any asset allocation which an investor chooses. Someone
desiring the large-cap exposure to domestic US equities would get the 500 largest stocks by market cap in the Smart
Value portfolio but in a proportion that gives weights in line with the discount to intrinsic value, i.e. overweight on
undervalued and underweight on overvalued stocks. AULU is Smart Value US Large Cap 500.
Smart Alpha is designed to provide an exposure to the most undervalued portion of the total market, i.e. 50 most
undervalued stocks from the largest 1500 stocks of US. This is a substitute for the traditional growth strategy. AUTX is
Smart Alpha (US Total Cap Extreme).
Smart Income is designed to provide an exposure to the most undervalued portion of the total market which is
optimized for providing dividend stability and income from dividends and capital gains. AUTD is Smart Income (US
Total Cap Income).
Now we compare the performance of ArthVeda Capital’s US indices, AULU, AUTX, and AUTD.
8
Smart Alpha During the Perfect Storm
Comparison of Value Masters with ArthVeda Indices
Figure 5
Value Masters vs. ArthVeda
(since 2003)
700.0
600.0
AUTD
500.0
AUTX
400.0
AULU
300.0
200.0
100.0
0.0
2003
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2014
AULU
AUTX
AUTD
GARIX
FAIRX
LLPFX
CFIMX
FPPTX
SGENX
FESGX
BEGRX
OAKLX
LMOPX
TWEBX
SEQUX
SPY
SPYV
SPYG
Berkshire
Source Capital
2015
Source: Thomson Reuters, ArthVeda Capital; Black lines indicate ArthVeda indices i.e. AULU, AUTX, AUTD; these are based on total returns index;
rebased to 100; performance of GARIX not available before 2013; data from 03-Jan-2003 to 31-Dec-2015
As evidenced from the Figure 5, the ArthVeda Smart Alpha indexes significantly outperform the Value Masters as well
as the markets. They seem to be the top-performers for most of the period and especially for the post-crisis period
the outperformance is significant. In fact, this is the kind of outperformance which was expected by the Value Masters
against the markets.
Smart Alpha During the Calm…
Figure 6 shows the performance during the pre-crisis period. Here too it is evident that the Smart Alpha indexes
outperform most of the Value Masters and the markets.
9
Figure 6
Value Masters vs. ArthVeda
(before recession)
300.0
250.0
200.0
150.0
100.0
50.0
0.0
2003
2004
2005
2006
2007
AULU
AUTX
AUTD
GARIX
FAIRX
LLPFX
CFIMX
FPPTX
SGENX
FESGX
BEGRX
OAKLX
LMOPX
TWEBX
SEQUX
SPY
SPYV
SPYG
Berkshire
Source Capital
Source: Thomson Reuters, ArthVeda Capital; Black lines indicate ArthVeda indices i.e. AULU, AUTX, AUTD; these are based on total returns index;
rebased to 100; performance of GARIX not available before 2013
Smart Alpha through Calm and the Storm…
Figure 7- Performance rank of Value Masters vs. ArthVeda – All years
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
LMOPX
Source Capital
FPPTX
Berkshire
Berkshire
SGENX
LMOPX
Source Capital
SEQUX
LMOPX
LMOPX
Berkshire
CFIMX
AUTD
FAIRX
SGENX
LLPFX
FAIRX
FESGX
Source Capital
FAIRX
AUTD
FAIRX
AUTD
AUTD
SPYG
SGENX
AUTX
FESGX
SPYV
SPYG
AUTD
FPPTX
FPPTX
AUTX
OAKLX
AUTX
OAKLX
SPY
FPPTX
AUTD
FAIRX
BEGRX
FESGX
TWEBX
LLPFX
AUTX
SPYG
Source Capital
AULU
SPYG
LMOPX
AUTX
SGENX
Source Capital
SGENX
SEQUX
SEQUX
OAKLX
AUTD
AULU
AUTX
OAKLX
AULU
SGENX
FESGX
FESGX
AUTX
FESGX
SGENX
FAIRX
AUTX
Berkshire
CFIMX
AULU
FAIRX
AUTX
FESGX
AULU
AULU
BEGRX
FAIRX
AUTD
AUTX
AUTD
AULU
OAKLX
SPYV
Source Capital
SPY
Source Capital
LLPFX
BEGRX
AULU
SPY
SPY
Berkshire
AULU
SEQUX
SPY
Berkshire
CFIMX
Source Capital
SPYV
BEGRX
LMOPX
AUTD
CFIMX
BEGRX
FPPTX
FAIRX
LLPFX
FPPTX
LLPFX
Berkshire
SPYV
AULU
OAKLX
SPYV
SEQUX
AUTX
SPYV
OAKLX
CFIMX
SGENX
SGENX
BEGRX
SPYG
LMOPX
OAKLX
SPYG
TWEBX
LMOPX
AULU
TWEBX
SPYV
SPYG
FESGX
SPYV
SPY
SEQUX
GARIX
BEGRX
SPY
FPPTX
SPYV
OAKLX
CFIMX
SPY
BEGRX
LMOPX
FESGX
SEQUX
SPY
SEQUX
TWEBX
FAIRX
SPY
OAKLX
LMOPX
AULU
AULU
TWEBX
SPYG
TWEBX
TWEBX
LLPFX
CFIMX
AUTX
SPYV
OAKLX
SPY
TWEBX
FPPTX
SPYG
SPY
SPYV
BEGRX
SPYG
SPYV
BEGRX
SEQUX
TWEBX
LLPFX
LLPFX
AUTD
LLPFX
BEGRX
SGENX
SPY
LLPFX
AUTD
GARIX
LLPFX
AUTD
Berkshire
CFIMX
SPYG
SPYG
AUTX
LLPFX
FESGX
CFIMX
Berkshire
CFIMX
BEGRX
TWEBX
GARIX
SEQUX
SPYG
TWEBX
SEQUX
LMOPX
Source Capital
SPYV
OAKLX
Source Capital
SGENX
FPPTX
SGENX
FAIRX
CFIMX
SEQUX
Berkshire
FPPTX
Source Capital
CFIMX
SEQUX
BEGRX
FAIRX
FPPTX
TWEBX
FESGX
Berkshire
Source Capital Berkshire
CFIMX
Source Capital
OAKLX
LMOPX
Berkshire
TWEBX
LMOPX
FESGX
SGENX
FPPTX
FPPTX
FESGX
FAIRX
LLPFX
Source: Thomson Reuters, ArthVeda Capital; Black Colours represent ArthVeda indices i.e. AULU, AUTX, AUTD; Red colours represent S&P 500
based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF (SPYV), SPDR S&P 500 Growth (SPYG); these are based on total returns;
performance of GARIX not available before 2013
10
Figure 7 shows the calendar year rankings for the funds. 8 out of 13 times since 2003, ArthVeda indexes are among
the top 5 performers in the list of value master funds and market index ETFs (SPY, SPYG and SPYV). In none of the
years were the Smart Alpha indexes at the bottom of the pile.
Smart Alpha over Long Periods…
Figure 8 shows the long period performance. For the long periods’ performance, ArthVeda indices are clear leaders by
being in the top 3 positions for 3 years, 5 years, 10 years and since 2003.
Figure 8 - Performance rank of Value Masters vs. ArthVeda – Long periods
3 Yr
5 Yr
10 Yr
Since 2003
LMOPX
SPYG
AUTD
AUTD
SPYG
AUTX
AUTX
AUTX
AULU
OAKLX
SPYG
AULU
CFIMX
AULU
AULU
SGENX
AUTD
AUTD
Berkshire
FESGX
SPY
SPY
SEQUX
SPYG
OAKLX
CFIMX
OAKLX
FAIRX
AUTX
SEQUX
SPY
OAKLX
Source Capital Source Capital
SGENX
SPY
Berkshire
SPYV
FESGX
Berkshire
SPYV
LMOPX
SPYV
LMOPX
BEGRX
Berkshire
FAIRX
Source Capital
SEQUX
BEGRX
Source Capital
SEQUX
GARIX
TWEBX
TWEBX
BEGRX
TWEBX
SGENX
CFIMX
SPYV
SGENX
LLPFX
BEGRX
FPPTX
FAIRX
FESGX
FPPTX
TWEBX
FESGX
FPPTX
LLPFX
LLPFX
LLPFX
FAIRX
LMOPX
CFIMX
FPPTX
Source: Thomson Reuters, ArthVeda Capital; Black Colours represent ArthVeda indices i.e. AULU, AUTX, AUTD; Red colours represent S&P 500
based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF (SPYV), SPDR S&P 500 Growth (SPYG); these are based on total returns;
performance of GARIX not available before 2013; as of 31-Dec-2015
Value Masters vs. Smart Alpha during Special Periods
The next question is how do the Value Masters and the Smart Alpha indexes perform in the various special periods.
We define 4 special periods, viz. Global Financial Crisis crash (June 01, 2007 to March 09, 2009), post-GFC recovery
(March 31, 2009 to September 30, 2010), Quantitative easing (November 01, 2010 to May 30, 2013) and QE Tapering
(June 01, 2013 to December 31, 2014).
Figure 9 shows that the performance of Smart Alpha indexes during the GFC crash is in line with the markets and the
performance of the Value Masters. Although, it is starkly visible that Buffett’s Berkshire is a clear “safe haven” during
any such crisis. Bill Miller’s Legg Mason is a stark laggard during this period. Value Masters did not outperform during
the crash.
11
Figure 9
Recession period performance
160.0
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
Jun-07
AULU
CFIMX
OAKLX
SPYV
Sep-07
Dec-07
AUTX
FPPTX
LMOPX
SPYG
Mar-08
AUTD
SGENX
TWEBX
Berkshire
Jun-08
Sep-08
FAIRX
FESGX
SEQUX
Source Capital
Dec-08
Mar-09
LLPFX
BEGRX
SPY
Source: Thomson Reuters, ArthVeda Capital; Black lines indicate ArthVeda indices i.e. AULU, AUTX, AUTD; these are based on total returns index;
rebased to 100; performance of GARIX not available before 2013
Figure 10 shows the performance during the recovery period. Now Miller’s Legg Mason fund redeemed itself with an
outstanding performance. However, the Smart Alpha indexes are the best performers after Miller. Berkshire is now a
laggard. Value Masters as a whole do not significantly outperform the markets even now. Although, most Value
Masters can be said to be doing better than the markets. But by no means all. This is surprising since at the bottom of
the markets there were a large number of mispriced stocks which were available significantly below their intrinsic
value. A Value Master of whatever ilk should have been able to realign their portfolios with the most high quality
undervalued stocks available and demonstrate a spectacular comeback as typical for most value investors after a crash.
But somehow this time it was different? Possibly, the perfect storm is still stormy. The dust, perhaps, has not settled
yet.
12
Figure 10
Recovery period performance
300.0
250.0
200.0
150.0
100.0
50.0
0.0
Mar-09
AULU
LLPFX
BEGRX
SPY
Jun-09
Sep-09
AUTX
CFIMX
OAKLX
SPYV
Dec-09
AUTD
FPPTX
LMOPX
SPYG
Mar-10
GARIX
SGENX
TWEBX
Berkshire
Jun-10
Sep-10
FAIRX
FESGX
SEQUX
Source Capital
Source: Thomson Reuters, ArthVeda Capital; Black lines indicate ArthVeda indices i.e. AULU, AUTX, AUTD; these are based on total returns index;
rebased to 100; performance of GARIX not available before 2013
Figure 11 shows the performance during the QE period. Again, the Value Masters seem to be struggling to outperform
the markets. The Smart Alpha indexes seem to be doing much better than the markets or the Value Masters.
Figure 11
QE Period
180.0
135.0
90.0
45.0
0.0
Nov-10
May-11
Nov-11
May-12
Nov-12
May-13
AULU
AUTX
AUTD
GARIX
FAIRX
LLPFX
CFIMX
FPPTX
SGENX
FESGX
BEGRX
OAKLX
LMOPX
TWEBX
SEQUX
SPY
SPYV
SPYG
Berkshire
Source Capital
13
Source: Thomson Reuters, ArthVeda Capital; Black lines indicate ArthVeda indices i.e. AULU, AUTX, AUTD; these are based on total returns index;
rebased to 100; performance of GARIX not available before 2013
Figure 12 shows the performance during the QE Tapering period. The Value Masters continue lagging the markets and
the Smart Alpha indexes continue outperforming both the markets and the masters.
Figure 12
Tapering period
150.0
120.0
90.0
60.0
Jun-13
AULU
Sep-13
Dec-13
AUTX
Mar-14
AUTD
Jun-14
GARIX
Sep-14
FAIRX
Dec-14
LLPFX
CFIMX
FPPTX
SGENX
FESGX
BEGRX
OAKLX
LMOPX
TWEBX
SEQUX
SPY
SPYV
SPYG
Berkshire
Source Capital
Source: Thomson Reuters, ArthVeda Capital; Black lines indicate ArthVeda indices i.e. AULU, AUTX, AUTD; these are based on total returns index;
rebased to 100; performance of GARIX not available before 2013
Figure 13 shows the performance in terms of ranks during the special periods. It is clear that the Value Masters in
general perform in line with the markets during this period except for the recovery period where they have a better
performance. It is also clear that the Smart Alpha indexes outperform both the markets and the masters except during
the crash during which they perform in line with the markets and the masters. ArthVeda’s Smart Alpha Indexes were
in the top 3 performers in all the other special periods defined above.
14
Figure 13 - Performance rank of Value Masters vs. ArthVeda – Special periods
Global Financial Crisis Post-GFC recovery Quantitative Easing QE Tapering
Jun 07 to Mar 09
Mar 09 to Sep 10
Nov 10 to May 13 Jun 13 to Dec 14
Berkshire
LMOPX
AUTX
AUTD
FESGX
AUTX
SEQUX
LMOPX
SGENX
AUTD
AUTD
OAKLX
SEQUX
Source Capital
AULU
AUTX
TWEBX
FAIRX
Source Capital
AULU
FAIRX
OAKLX
OAKLX
SPYG
SPYG
FPPTX
SPYV
Berkshire
AUTD
AULU
CFIMX
SPY
FPPTX
LLPFX
SPY
Source Capital
SPY
CFIMX
SPYG
SPYV
AUTX
SPYG
Berkshire
GARIX
BEGRX
TWEBX
BEGRX
SEQUX
AULU
SPY
LLPFX
CFIMX
SPYV
BEGRX
FPPTX
LLPFX
OAKLX
SPYV
TWEBX
BEGRX
LLPFX
SGENX
LMOPX
TWEBX
Source Capital
Berkshire
FAIRX
SGENX
CFIMX
FESGX
SGENX
FPPTX
LMOPX
SEQUX
FESGX
FESGX
FAIRX
Source: Thomson Reuters, ArthVeda Capital; Black Colours represent ArthVeda indices i.e. AULU, AUTX, AUTD; Red colours represent S&P 500
based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF (SPYV), SPDR S&P 500 Growth (SPYG); these are based on total returns;
performance of GARIX not available before 2013
Value Masters are Human too
So, this outperformance of the ArthVeda indexes brings another question to the fore. Why are majority of the Value
Masters unable to beat ArthVeda indexes? The likely explanations of this underperformance are:


There are behavioural biases of the Value Masters regarding the future prospects of the businesses in which
they invest in, which is possibly catalysed by the information they get from various sources (company
management, news feed, primary research etc.). ArthVeda’s Smart Alpha Index portfolio creation is entirely
based on published fundamentals and only those companies which have shown a strong track record of high
quality fundaments are selected in the portfolio.
The Value Masters are tilted more towards concentrated portfolios. The concentrated portfolios of the value
masters and possibly their unwillingness to sell an underperforming position and switch to more
attractive/undervalued positions might be a cause. Because of their behavioural bias in the positions they have
invested, they probably wait too long for those large bets to work, even when there are other attractive
positions available, relatively, in the market. Since their portfolios are concentrated, hence each of their bets
is large; the underperformance of those large bets possibly put a significant drag on the overall portfolio
performance.
15


As explained in the comparison with markets, ArthVeda’s diversified portfolio selection (hence less
concentration) also helps in achieving the outperformance.
The rebalancing of the portfolio using the new financial information published every quarter based on the
relative attractiveness of the holdings and available securities also contributes to the outperformance.
Therefore, to answer Lowenstein questions outlined in the start, we conclude that:

Are there rational investors out there?
Yes, there are rational investors out there and they are value investors in the Graham-and-Buffett mould.

Did they achieve results different from the market?
Yes, the Value Masters achieve results different from the markets but can also lag the markets in the short to
medium term.

Did they outperform the markets significantly?
No, in certain difficult and long periods the Value Masters can lag, such as, the 2003 to 2015 period. But eventually
they are likely to come out ahead as markets get priced fairly (Voting machine vs. Weighing machine).

Can we still assume the markets are efficient?
No, markets are unlikely to be efficient ever in the sense of pricing all stocks fairly all the time.

Do they hold a concentrated or diversified portfolio?
The human Value Masters do hold concentrated portfolios, but there is a new way of creating more diversified
portfolios that are bought at discount to intrinsic value in a manner consistent with the Graham-and-Buffettsville,
ArthVeda’s Smart Alpha way.

Do they buy and hold or trade frequently?
The human Value Masters buy and hold for years at a time but there is a new way of creating a portfolio that can
be traded slightly more frequently in response only to published financials but which is consistent with the basic
principles of Graham-and-Buffettsville.
Definitely the “Perfect Storm” is not over and possibly once the dust settles the performance of the Value Masters will
improve. But, ArthVeda’s Smart Alpha indexes might be one way of taking exposure to true value investing in a more
consistent manner free from human behavioural biases which even the Value Masters might be prone to.
16
Appendix
Figure 14 - Year wise total returns
AULU
AUTX
AUTD
BEGRX
Berkshire
CFIMX
FAIRX
FESGX
FPPTX
GARIX
LLPFX
LMOPX
OAKLX
SEQUX
SGENX
Source Capital
SPY
SPYG
SPYV
TWEBX
2003
31.8%
42.5%
34.8%
27.6%
17.0%
15.9%
23.3%
34.6%
35.4%
na
30.9%
63.8%
25.7%
16.2%
35.6%
15.5%
23.8%
24.4%
21.4%
20.2%
2004
15.8%
23.0%
23.5%
14.5%
4.3%
5.9%
24.9%
17.6%
10.9%
na
7.1%
13.8%
9.7%
4.7%
18.4%
28.1%
10.7%
5.3%
13.2%
12.6%
2005
8.0%
7.9%
9.5%
9.3%
0.8%
-0.3%
13.7%
14.1%
16.5%
na
3.6%
6.7%
4.8%
7.8%
14.9%
11.2%
4.8%
2.8%
5.4%
2.3%
2006
14.9%
11.1%
14.9%
21.0%
24.1%
15.3%
16.7%
19.6%
5.4%
na
21.6%
13.4%
13.6%
8.3%
20.5%
-2.0%
15.8%
9.0%
21.6%
11.6%
2007
0.0%
5.6%
-1.0%
3.0%
28.7%
0.1%
12.4%
9.1%
-0.4%
na
-0.4%
-1.6%
-14.0%
8.4%
7.8%
-5.6%
5.1%
10.8%
1.4%
0.6%
2008
-36.9%
-23.0%
-30.5%
-40.4%
-31.8%
-49.6%
-29.7%
-21.7%
-34.8%
na
-48.6%
-65.5%
-36.2%
-27.0%
-21.1%
-49.3%
-36.8%
-37.4%
-36.3%
-24.4%
2009
41.1%
45.5%
49.5%
29.8%
2.7%
37.6%
39.0%
22.0%
53.8%
na
53.6%
83.1%
52.5%
15.4%
22.9%
60.8%
26.4%
37.0%
17.1%
27.6%
2010
19.8%
23.5%
23.7%
11.1%
21.4%
14.8%
25.5%
16.7%
24.2%
na
17.9%
16.6%
13.2%
19.5%
17.6%
30.7%
15.1%
16.2%
15.5%
10.5%
2011
3.0%
5.7%
5.4%
-2.1%
-4.7%
2.3%
-32.4%
-0.9%
0.9%
na
-2.8%
-34.9%
2.1%
13.2%
-0.2%
-6.0%
1.9%
4.6%
-0.7%
-1.7%
2012
17.7%
13.9%
18.8%
16.4%
16.8%
12.3%
36.9%
9.0%
9.7%
na
16.5%
39.6%
21.7%
15.7%
9.9%
19.0%
16.0%
14.2%
17.2%
15.4%
2013
39.8%
41.8%
41.6%
29.1%
32.7%
34.2%
36.0%
14.6%
22.8%
29.8%
32.1%
66.8%
36.5%
32.4%
15.5%
34.9%
32.3%
32.6%
31.8%
22.7%
2014
14.3%
17.8%
13.9%
6.8%
27.0%
7.3%
-2.7%
2.2%
-1.3%
9.3%
4.9%
10.0%
15.4%
7.6%
2.9%
13.2%
13.5%
14.8%
12.2%
4.0%
2015
-3.4%
-8.8%
-5.9%
-4.1%
-12.5%
6.4%
-11.5%
-1.7%
-17.2%
-10.2%
-18.8%
-0.2%
-3.6%
-7.3%
-0.9%
-1.8%
1.3%
5.1%
-3.2%
-5.4%
Source: Thomson Reuters, ArthVeda Capital; Black Colours represent ArthVeda indices i.e. AULU, AUTX, AUTD; Red colours represent S&P 500
based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF (SPYV), SPDR S&P 500 Growth (SPYG); these are based on total returns;
performance of GARIX not available before 2013; data from 03-Jan-2003 to 31-Dec-2015
Figure 15 - Long period total returns
AULU
AUTX
AUTD
BEGRX
Berkshire
CFIMX
FAIRX
FESGX
FPPTX
GARIX
LLPFX
LMOPX
OAKLX
SEQUX
SGENX
Source Capital
SPY
SPYG
SPYV
TWEBX
3 Yr
15.5%
15.1%
14.9%
9.8%
13.8%
15.3%
5.4%
4.8%
0.1%
8.4%
4.0%
22.3%
15.0%
9.7%
5.6%
14.4%
15.0%
17.0%
12.7%
6.5%
5 Yr
13.3%
12.9%
13.7%
8.5%
10.4%
12.0%
1.6%
4.5%
2.1%
na
5.0%
10.7%
13.6%
11.6%
5.3%
10.9%
12.4%
13.8%
10.7%
6.5%
10 Yr
8.6%
11.5%
10.7%
4.9%
8.4%
4.9%
5.7%
6.1%
3.8%
na
3.7%
3.2%
7.3%
7.4%
6.7%
5.2%
7.2%
8.7%
5.9%
5.1%
Since 2003
10.8%
14.2%
13.3%
7.6%
8.1%
5.4%
9.0%
9.5%
7.5%
na
5.8%
8.0%
8.6%
7.9%
10.2%
8.0%
8.5%
9.1%
7.5%
6.5%
17
Source: Thomson Reuters, ArthVeda Capital; Black Colours represent ArthVeda indices i.e. AULU, AUTX, AUTD; Red colours represent S&P 500
based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF (SPYV), SPDR S&P 500 Growth (SPYG); these are based on total returns;
performance of GARIX not available before 2013; as of 31-Dec-2015
Figure 16 - Special period returns
Global Financial Crisis Post-GFC recovery Quantitative Easing QE Tapering
Jun 07 to Mar 09
Mar 09 to Sep 10
Nov 10 to May 13 Jun 13 to Dec 14
AULU
-57.5%
69.8%
52.7%
34.1%
AUTX
-54.3%
82.4%
59.1%
35.1%
AUTD
-49.2%
80.9%
54.3%
40.0%
GARIX
na
na
na
25.0%
FAIRX
-47.9%
72.9%
24.3%
9.5%
LLPFX
-62.7%
67.3%
36.6%
21.4%
CFIMX
-64.5%
62.6%
46.4%
21.4%
FPPTX
-53.0%
71.5%
36.0%
10.7%
SGENX
-35.0%
44.4%
23.6%
11.2%
FESGX
-34.6%
42.8%
21.2%
9.9%
BEGRX
-55.1%
45.5%
37.2%
19.6%
OAKLX
-60.7%
71.7%
48.0%
36.4%
LMOPX
-81.4%
113.6%
30.9%
37.9%
TWEBX
-45.5%
48.7%
33.1%
13.3%
SEQUX
-41.9%
41.7%
57.7%
22.3%
SPY
-54.1%
47.9%
45.3%
29.5%
SPYV
-57.7%
44.6%
46.8%
25.8%
SPYG
-48.9%
51.7%
44.7%
32.9%
Berkshire
-33.0%
43.6%
43.1%
32.2%
Source Capital
-63.4%
77.5%
51.6%
26.2%
Source: Thomson Reuters, ArthVeda Capital; Black Colours represent ArthVeda indices i.e. AULU, AUTX, AUTD; Red colours represent S&P 500
based ETFs, i.e. SPDR S&P 500 ETF (SPY), SPDR S&P 500 Value ETF (SPYV), SPDR S&P 500 Growth (SPYG); these are based on total returns;
performance of GARIX not available before 2013
18
Disclaimers
About ArthVeda Capital
ArthVeda Capital is the equities vertical of global asset management firm ArthVeda Fund Management Pvt. Ltd.
ArthVeda Capital is an innovative, top-ranked global asset management firm known for its patent pending, SMART
ALPHA™ framework providing an investment grade equity™ portfolio. ArthVeda Capital is ranked #1 Long-bias equity
strategy out of more than 11,000 hedge funds worldwide by Preqin for calendar year 2014. It has also emerged as a
leader in 2016 Hedge Fund Awards by Acquisition International and APAC Insider’s 2016 Investment Awards. ArthVeda
is a Registered Investment Advisor with the US SEC. ArthVeda is in the process of launching a number of ETFs in the
US and other long-bias equity schemes from its Mauritius and Luxembourg-based funds, including UCITS. For more
information please visit http://www.arthvedacapital.com/.
© 2015 ArthVeda Fund Management Pvt. Ltd. The content is copyright of ArthVeda Fund Management Pvt. Ltd. All
rights reserved. Patent pending.
ArthVeda SMART VALUE US Large-cap 500 (AULU) audited by Deloitte Touche Tohmatsu India Private Limited for
multiple aspects including but not limited to detailed strategy creation, use of accurate publicly available fundamental
data and absence of biases in the model.
ArthVeda has registered Trade Mark for the following marks: ARTHVEDA, WEALTH FROM WISDOM, INVESTMENT
GRADE EQUITY, DISCOUNT TO INTRINSIC VALUE, D2IV, STRUCTURED VALUE INVESTING, ARTHVEDA SMART XTREME,
ARTHVEDA SMART VALUE, ARTHVEDA SMART INCOME, ARTHVEDA SMART ALPHA.
Past performance is not necessarily indicative of future results.
ArthVeda indices are based on quarterly rebalanced model portfolio started on Jan 3, 2003 and back tested over 200315. It is not possible to invest directly in an index. AVFM Indices do not sponsor, endorse, sell, or promote any
investment fund or other investment vehicle that is offered by third parties and that seeks to provide an investment
return based on the performance of any index. This document does not constitute an offer of services in jurisdictions
where AVFM Indices does not have the necessary licenses. AVFM Indices receives compensation in connection with
licensing its indices to third parties.
AVFM does not guarantee the accuracy and/or completeness of the Indices, makes no express or implied warranties
with respect to the Indices and shall have no liability for any damages, claims, losses or expenses caused by errors in
the index calculation. AVFM makes no representation regarding the advisability of investing in options on the Index.
This communication is not an offer to sell or a solicitation to buy the securities mentioned. The information relating to
any company herein is derived from publicly available sources and ArthVeda Fund Management (AVFM) makes no
representation as to the accuracy or completeness of such information.
Due to the compounding of daily returns, returns over periods other than one day will likely differ in amount and
possibly direction from the target return for the same period. These effects may be more pronounced in funds with
larger or inverse multiples and in funds with volatile benchmarks.
This material is prepared by ArthVeda Capital for distribution to institutional clients. The material may include
summaries and references to AVFM Research Reports, for a complete list of company reports please refer to the
following link http://www.arthvedacapital.com/research/white-papers/. These company reports also contain
19
important disclosures, analyst certifications and investment banking related disclosures. For a complete list of
disclosures
please
refer
to
the
following
link:
http://www.arthvedacapital.com/wpcontent/uploads/2015/09/Disclosure-document-03.09.2015.pdf. The views contained herein are those of ArthVeda
Capital and may differ from those of the AVFM Research Department. This material should not be deemed as the only
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AVFM makes no representation as to the accuracy or completeness of information contained in this communication.
Important Notice:
An investor should consider the investment objectives, risks, and charges and expenses carefully before investing. The
prospectus can be accessed through the website of the U.S. Securities and Exchange Commission at the following
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This material is intended for informational purposes only. It is not an invitation or offer to purchase investments
offered through ArthVeda Fund Management (AVFM). Any representation to the contrary is not permitted. Past
performance is not necessarily indicative of future results.
ArthVeda Fund Management Pvt. Ltd.
Grd. Floor, HDIL Towers, Anant Kanekar Marg, Bandra (E),
Mumbai 400051, Maharashtra, India
Contact no.: +91 22 67748500/591;
Fax: +91 22 67748585
www.arthvedacapital.com
[email protected]
i
LOWENSTEIN, LOUIS. "SEARCHING FOR RATIONAL INVESTORS IN A PERFECT STORM (2005)." JOURNAL OF CORPORATION LAW
30: 539
ii KLARMAN, SETH. "A RESPONSE TO LOWENSTEIN’S SEARCHING FOR RATIONAL INVESTORS IN A PERFECT STORM’(2005)."
JOURNAL OF CORPORATION L AW 30: 561-561.
iii BUFFETT, WARREN (2004). "T HE SUPERINVESTORS OF GRAHAM -AND-DODDSVILLE ". HERMES : THE COLUMBIA BUSINESS SCHOOL
MAGAZINE : 4–15.
20