Brandes On Value: The Independent Investor
McGraw Hill Education, 2014.
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Just to mention up front, I have been a member of the Brandes Institute since 2003. This is a research group that naturally has a value orientation, but also covers many other areas of investment research as detailed on its website.1 Charles Brandes, a colleague of Ben Graham, founded the institute and has contributed to our industry in many ways. He spoke at the CFA Society Toronto’s ‘Annual Forecast Dinner’ and was very well-received. His book, Brandes on Value, which he gave out to each of the tables (over 50 copies) at the dinner, presents valuable long-term insights into the field of value investing.
In 1971, shortly before he founded Brandes Investment Partners in San Diego, CA, he was an investment dealer fresh out of school when he met Graham, the father of value investing,2 in La Jolla, CA. Graham lived there after retiring from teaching at Columbia and the two met frequently: Brandes had read Graham’s two books3 and soon became a fervent disciple of value investing.
His latest book is a follow-up to his 2004 book – Value Investing Today.4 It provides a broad and timely update on a myriad of tumultuous topics that have evolved since his first book, all in a very clear and enjoyable fashion.
The book is divided into four parts covering:
- ‘Why do value investing’ which discusses 50 years of market history and shows what value investing has produced over this period: higher returns, lower volatility, and lower trading costs
- ‘Where one finds value’ where he covers behavioural biases, Graham’s concepts of intrinsic value and the margin of safety, and the fact that value can be found everywhere around the world
- ‘Value investing in an ever-changing market’ which discusses a myriad of topics including: value versus glamour, shorting, 130/30 funds, target date funds, active versus passive indexing, smart beta, fixed income, and hard assets (gold, commodities, art, and real estate)
- ‘Value in portfolio management’ where he discusses long-term superior performance of equities despite periods of negative returns, including a discussion of types of portfolio risk, and a very well-done discussion of value investing in bonds, an often overlooked topic that was one of Graham’s favourite topics
A number of the major themes run throughout the book of which I would like to mention three: behavioural biases, the need for independent judgment, and the long-term view.
Behavioural Bias in real-world investing continuously presents opportunities in value stocks.
People unconsciously make investment decisions based on psychological biases. Studies in behavioural finance have identified the main flaws as faulty intuition, extrapolation, over-optimism, anchoring, and hindsight. As Brandes says, “Value investing ... based on decisions on fundamentals and looking for cheap and often out-of-favour stocks has proven to be successful over 80 years ... certainly before behavioural finance became a topic of formal study.”
Efficient Markets Theory (EMT) is a very compelling section under biases, respectfully outlining the weak, semi-strong, and strong forms and noting it still has many followers. In Brandes’ view, however, the 1987 crash, in which the Standard & Poor’s 500 fell by 30 per cent in six days, and the rise (late 1990s) and fall (early 2000s) of the dot com bubble6 clearly reflect a shortfall in EMT. The examination of the 1987 and late 1990s market moves also includes numerous examples of individual stocks. Brandes cites the late value investing academic Robert Haugen, who studied EMT throughout the 1990s and concluded “ ... the market is highly inefficient and over reactive ... ” Haugen has good company in Charles Munger and Warren Buffett (lectures and letters), Robert Shiller (Irrational Exuberance), and other luminaries. Brandes’ overall summary is that “... knowledge and experience are essential ... but ... insight into investor behaviour and how it influences the value of companies is empowering.”
- Independent Judgment is how value investors must be willing to swim against the tide of Popular opinion.
Brandes recognized this in his early days with Graham and practiced this throughout his 40 years with Brandes Investment Partners. Past examples of the difficulty of going against the trend include staying out of Japan in the 1980s before it began its lost decade; the beginning of the dot com bubble in the late 1990s when value lagged badly; and the financial crisis of 2008/2009 when value stocks bore the brunt of the early selloff.
Value stocks subsequently performed quite well, but the lesson is clear that value investors must be able to withstand criticism of their independent judgment and stick with their beliefs – all in their clients’ interests.
- Long-Term View is essential in value investing. Brandes shows a 40-year (1974-2014) comparison of rolling three-year MSCI EAFE performance versus the S&P.
From about 1990 to the early 2000s, the S&P outperformed EAFE, but there were several other long periods when the opposite happened. The point is that value investors have to follow both and continually search for value in these two markets. Another chart shows that over the period 1977-2013, the S&P far outperformed gold, commodities, global equities, and U.S. bonds, despite substantially underperforming each of these asset classes during some intervals. This evidence once more demonstrates value clearly outperforming over the long-term, despite interim periods of underperformance.
Brandes on Value covers a myriad of investment topics over the past 50 years and value investing’s performance, role, and qualities in these quite variables times. The book is written in a very clear, informative, and readable fashion with topics appropriately grouped under the four parts outlined above. With his clear and concise prose, Brandes is especially adept at explaining these complex topics. His text is well-augmented by extensive references and data. All in all, Brandes on Value is a highly worthwhile contribution to the literature on value investing – not to mention, how many value investors today knew, worked with, and became a disciple of this discipline from non-other-than Ben Graham himself?
Bruce Grantier (CFA) is founder of InvestorLit.com.
2. The book has a letter dated March 1, 1974 from Graham, congratulating Brandes on the founding of his new firm
3 .Benjamin Graham and David Dodd, Security Analysis, McGraw Hill, 1934. Benjamin Graham, The Intelligent Investor, Harper and Row, 1949
4. Charles H. Brandes, Value Investing Today, McGraw Hill, 2004