The Measured Approach to Value

Research Magazine, April 2012I was recently interviewed for Research Magazine’s article The Measured Approach to Value by Gerald Burstyn. You can read the interview here (I am featured mostly on the second page). One thing to note: I am incorrectly referred to as a Chartered Financial Analyst. While I have passed the three exams, I have not yet received the Charter. Otherwise, it feels pretty great to be featured in the same article as Vitiliy Katsenelson and David Merkel.

Only a bit of the interview made it in so for those interested below is the full content of the interview.


Research Magazine: Please tell me about your decision to focus on a value investing approach. Who are your heroes or influences in the field? How did you come to it?

Frank: There is a quote from Warren Buffett that value investing is “like an inoculation — it either takes or it doesn’t” in that once you are exposed to the concepts, you either get it immediately or you don’t. I had the good fortune of completing my MBA with my now close friend Saj Karsan (of the Karsan Value Fund and, who first suggested that I read Benjamin Graham’s The Intelligent Investor, which Buffett called “by far the best book on investing ever written.” Thankfully I took Saj’s advice, and immediately the concepts took hold. Something “clicked” and I found that all I wanted to do was learn more about it.

After The Intelligent Investor, I voraciously read as many books about value investing and famous fundamental investors as I could find, even tracking down an ultra-rare copy (See here) of Seth Klarman’s Margin of Safety at a public library in New Zealand.

I recognized quite early that understanding the concepts is one thing, but putting them into practice is much more difficult and requires a significant amount of technical knowledge. Luckily, at the time I was completing both the MBA and a Law degree, so I shifted my focus toward the fundamentals of accounting and finance as well as corporate transactions such as mergers and reorganizations. On the advice of my brother-in-law, I completed the three CFA exams while still in school, which provided added breadth and depth to my analytical toolbox that I found missing from the more generalized curriculum of the MBA. I thought these would make me a better investor. The jury is still out!

After graduation, I was staring into a historically poor job market for financial professionals, especially those new to the industry like myself. Quite simply I could not find a job. As they say, entrepreneurship is the offspring of necessity, so I decided to try my hand at investing full-time. Given my focus on value investing up to that point, there was never any question that I would try anything else.

I created as a way of keeping track of my investment ideas, with the hope that reader comments would help me identify my weaknesses. It also kept me honest, in that anyone would be able to go back and see how my calls performed in retrospect. However, I think the greatest benefit to me was the simple act of putting my ideas into words. A lot of individual investors skip this, but I believe this has been invaluable. There have been countless times where I start writing with one view, only to reach a different conclusion as I work through the write-up. As I write, I frequently find chinks in the armor, which then leads to more research and investigation. Sometimes I uncover scary things, while other times I find hidden value in explanations for things I once thought were risks.

I think different investors have influenced me more and less at different times. When I started out, I had little confidence in my ability to detect the Buffett and Munger style franchises capable of persistently earning supernormal returns thanks to a sustainable competitive advantage. As a result, I focused on the discarded “cigar butts” of Buffett’s youth, with a spare puff remaining. At this stage, I think the earlier value investors, such as Benjamin Graham and Walter Schloss, were the biggest influences, along with Buffett’s earlier writings. Joel Greenblatt’s book You Can Be a Stock Market Genius, was also instrumental.

As time has marched on (and the market has strengthened considerably), these cigar butts are to be found less frequently, and I have spent more time focusing on track records and competitive strategy. This, for me, entails far less emphasis on quantitative analysis, as I spend a lot more time reading qualitative disclosures, seeking to identify risks and opportunities. This type of investing is almost as much a war with yourself as it is with the market, as qualitative analysis lends itself much more so to individual biases. As a result, I have been working diligently to expand on the CFA curriculum’s coverage of behavioural biases to read books by Michael Mauboussin of Legg Mason, Howark Marks of OakTree Capital, and James Montier if GMO. Some other investors who have influenced me at this stage include David Einhorn of Greenlight Capital and Bruce Berkowitz of the Fairholme Fund (who, despite an atrocious 2011, had the mental fortitude to stick with his thesis. This is a difficult thing to do, and I believe he’ll be labeled the come-back kid in a few years).

Research Magazine: Please tell me about your early and later history as a value investor. How have you done over time? What have you learned as you went along the way?

Frank: I think I covered much of this in the final two paragraphs of my last answer, but I’ll add a few things here.

2011 was a particularly rough year, both for myself and for fundamental investors generally. This chart shows how hedge funds with fundamental strategies performed over the year relative to other strategies.

There are many reasons for this underperformance. For myself, I played into the macroeconomic headfake that occurred in late 2010 and early 2011. Positive economic news was being released weekly and I believed the economy was on solid footing. Then we had an endless stream of negative events from the Japanese Tsunami and Arab Spring to the US debt ceiling debacle and the resurgence in the European debt crisis. All of this appeared to frighten consumer and companies alike and for the second half of the year it looked like a double dip was a real possibility. The resulting risk-on/risk-off volatility and high correlations led to the fundamentals of companies being ignored as the market sank. I found myself too long the market, and having waded in further at precisely the wrong time. I spent the remainder of 2011 atoning for my sins and reducing exposure.

The biggest lesson from all of this is that, for fundamental investors, the macro landscape matters, and much more so than any of the value investing books will tell you. A good book on investing in this type of market is Vitaliy Katsenelson’s The Little Book of Sideways Markets. Vitaliy is another value investor whose commentary (and discussion of sideways markets) has been a big influence over the last year. Two investors whose views on the macroeconomy I find particularly enlightening are Hugh Hendry of Eclectica Asset Management and Kyle Bass of Hayman Capital.

So far I have outperformed the S&P and Dow in 2012. I continue to reduce exposure, as I see major problems brewing in China and Japan, which will have a big impact on commodity-based economies like Canada and Australia, and I am not confident that we have seen any substantive progress in Europe.

Research Magazine: What about value investing now? Is it a good approach in the 2012 market? Is it always a good approach? How does a value approach trump a non-value approach today?

Frank: Though I believe value investing, in terms of investing based on a company’s fundamentals and buying companies at a sizable margin of safety relative to their intrinsic values, is always the right approach in the long run, it is not always the best performing approach in the short run. As shown in the chart above, when the markets are highly correlated and extremely choppy, the fundamentals are often ignored for long stretches. As such, I think it is extremely important to include a macro analysis overlay to identify potential risks and (to a lesser extent) opportunities.

So far, 2012 appears quite similar to 2011, in that the markets are performing quite well so far, largely on strengthening economic news out of the US and the European debt crisis fading ever so slightly into the background. For value investors today, the best advice I would give would be to not assume we’ll see a recovery in the near term (despite how the economic reports are pointing) and continue to be viligent in demanding a sizable margin of safety. Investors need to get comfortable sitting on cash for extended periods of time, even as the market might soar in the short run (this is a lesson common among the value investing great, including Seth Klarman and Prem Watsa of Canada’s Fairfax Financial). If I had listened to this advice in early 2011, I would have had significantly greater firing power in the depths of August and September.

If by non-value approach you mean a growth approach, I think it would be an extremely risky proposition in the current market. We’ve seen companies cut expenses to the bone, and (as Vitiliy Katsenelsen shows here) so corporate margins are near their all-time highs. A growth strategy would thus need to rely on top line growth, which is a necessarily risky proposition in the midst of a shaky recovery with significant fragility in most of the world.

Research Magazine: Please tell me what kind of investor you need to be to take the value approach. That is: patient, educated, risk averse? In other words, what are the characteristics of a good value investor?

Frank: I think successful value investing requires an extreme dedication to logic and intellectual honesty. The easiest person to fool is yourself, and oftentimes you do so without even trying. You have to be comfortable identifying what elements of your thesis you are assuming and what elements you know as fact, and then work diligently to test your assumptions.

In the best cases, you find a company that is cheap even using the worst case scenarios you can realistically conceive of, which makes the job somewhat easier. But most companies don’t fit this scenario and, especially as the market rises, there is a lot of grey area where the company may only be cheap in some scenarios. This is where intellectual honesty becomes extremely important.

One of my heroes in terms of a focus on intellectual honesty is Ray Dalio of Bridgewater Associates, the world’s biggest hedge fund. Though he follows macro strategies rather than fundamental value, he has a reputation for demanding a high level of intellectual rigour among his employees and fostering an environment where assumptions and investment theses statements are challenged by everyone, regardless of rank, in what Dalio calls “radical transparency.” For successful investing, there can be no place for ego or pulling rank.

Another investor whose writing has been particularly impactful in this regard is Sardar Biglari of Biglari Holdings. Though he is an activist investor, taking positions and agitating for change, a review of his letters shows a real commitment to intellectual honesty and holding people accountable for their actions.

Since you raised it, I don’t think formal education is a necessity for successful investing. However, it is certainly the easiest way to get a lot of exposure to a lot of different things, all at once. No company will expose you to marketing, strategy, accounting, finance, and the legal department, all at once. For me, the best learning I did was on my own, and probably the best thing to come from my education was meeting Saj and getting introduced to value investing. Also, I would recommend the CFA curriculum over an MBA, and I think my Law degree has been far more useful in terms of inculcating in me the importance of intellectual honesty than anything else I have ever done.

There are two good examples that immediately come to mind of people who were uneducated but have become great investors. The first is Francis Chou, who is one of Prem Watsa’s disciples. He has grown his flagship Associated fund by a a compound annual growth rate of 10.3% since 1987, all with just a high school education (and later the CFA charter) and a high dose of intellectual honesty. The other is Allan Mecham, who is a 34 year old college drop out who runs Arlington Value Management and has managed to return a cumulative 400% return over the last twelve years (including 11% in 2008 and 59% in 2009, as the rest of the market tanked!).

One of the things I like about investing as compared to many other areas of finance is that it does not matter who you are, who you know or where you come from. You will succeed if you are disciplined, logical and intellectually honest.

Research Magazine: Please tell me some of your favorite value stocks, funds, or ETFs at this time.

Frank: I think traditional electronics retailers are historically cheap right now. Best Buy (NYSE: BBY), Radioshack (NYSE: RSH), GameStop (NYSE: GME) and the lesser known hhgregg (NYSE: HGG) have suffered due to weak consumer demand, but have extremely strong balance sheets, historically strong returns over long periods of time, and capable, shareholder friendly managements. There is an oft-repeated warning that Amazon is turning these brick-and-mortar locations into its show room, and this is a definite threat. However, these companies aren’t standing still (particularly Best Buy and GameStop, which have had impressive accomplishments online) and I don’t think their current prices are justified, even in pessimistic scenarios. These companies will benefit as the economy does recover, and in the meantime they are still earning strong double-digit returns on invested capital while opportunistically repurchasing shares, which will favour the long-term investor.

Another opportunity is Urbana Corp (TSE: URB), a Toronto-based investment company with holdings in the financial sector, including public holdings such as CBOE Holdings, NYSE Euronext, and Bank of America as well as private holdings such as the Bombay and Budapest stock exchanges. The bulk (by value) of its assets are easily valued because they are publicly traded, and Urbana trades at a significant (~40%) discount to its book value. At the same time, the investment manager, Tom Caldwell, has been aggressively repurchasing shares (though he is somewhat limited by Ontario’s paternalistic securities laws). As the financials recover, Urbana stands to benefit doubly, from both an increase in book value and a correction of the current discount to book value. I should note also that Caldwell publishes the fund’s full holdings on a weekly basis, providing transparency that is virtually unheard of.


Author Disclosure: Long BBY, RSH, GME, HGG, URB 

Talk to Frank about this interview

  • markets have the final say

    don’t you think utility of CFA for an investor is also overrated?

    • Frank Voisin

      Definitely not. While I think there is a lot of content that is perhaps not useful for value investors, I think the breadth and depth of the material in the CFA curriculum is unparalleled and provides an excellent grounding in every topic that I can think of that would be necessary for investors. Furthermore, the difficulty of the exams is such that you can’t just float by without actually learning the content (this stands in stark contrast to MBA programs).

      Mastering the CFA curriculum will not guarantee superior returns, if that is what you are asking. But what it will do is introduce you to everything finance has to throw at you, and then leave it up to you to make your own way without the added challenge of dealing with unfamiliar territory.

  • Undecided about CFA

    Nice Interview. I didn’t know you had an MBA and law degree and about to get a CFA. Way to go !!

    I am an engineer and work in the tech sector and was wondering how I can get my CFA. Don’t you need to work in a securities firm for a few years for the 3rd exam before you can get the charter? This is quite difficult for me at this stage of my life. How would you suggest people like me proceed if they want to get a CFA. Any other advice thoughts in general would be much appreciated.

    • Frank Voisin

      If you want the CFA Charter, one of the requirements is related work experience. If you want to complete the CFA curriculum but care less about the Charter (e.g. you plan to stay in Engineering where the Charter may not be as valued), then there is nothing stopping you from studying and writing the exams.

  • Jon

    Wow, I was coming to the site today to inquire whether it would be appropriate for you to eat some crow on your recommendations for Research in Motion (NYSE: RIMM), Best Buy (NYSE: BBY), Radioshack (NYSE: RSH), and GameStop (NYSE: GME). Despite your recent admission to cycling into cash, I guess you’re standing by or doubling down on these recommendations…?

    • Frank Voisin

      Hi Jonathan

      First, I feel it is necessary to make it clear that I don’t make recommendations. It would be both inappropriate and unethical for me to recommend specific securities without assessing a person’s portfolio, risk tolerance, etc. I am merely putting my views online for discussion and hopefully to draw attention to interesting things. It seems to be going well.

      Second, you are correct that several of my long positions have declined in value. While this is disappointing, it does not mean that anything has necessarily changed with the company’s fundamentals. I do not think the decline at Best Buy or Gamestop are even remotely justified and I do stand by those positions. The fundamentals of these companies are strong and I think the shorts at GME are particularly misguided.

      RIMM is a different story, where I am absolutely shocked that the past co-CEOs stood by without taking real action. The Board failed to hold them accountable until they eliminated a once dominant lead into a distant third position in consumers’ minds. The fundamentals clearly deteriorated, and I do not think I will achieve my past price target. I would admit that this was most likely a mistake. I’ll eat crow on this one.

      That said, I am heartened to hear the new CEO’s comments and I think that if there is a turnaround to be had, he’s the one for the job.

      Radioshack is a more difficult situation, since only the past quarter seemed to be fundamentally weak (massive gross margin contraction). Only time will tell whether their gross margins from last quarter will persist, or whether this is a transitory issue that will mean revert in a few quarters. I am also quite shocked that they would announce their intention to stop repurchasing shares rather than just not using their repurchase program for a quarter or two. This was an absurdly ill conceived decision, and the market punished them thoroughly for it.

      I still think BBY, GME, RSH and HGG are very cheap, and I would gladly buy shares in any of them at these prices.


      • Jon

        Thanks for your response Frank and I hope I wasn’t needling you (too much). :D

        • Frank Voisin

          And thank you for keeping me honest!


          • Jon

            My pleasure. Oh, typically you provide a disclosure statement as to which securities you own…shall we take your omission of this statement from the post on your interview to mean you’ve sold off these names?

          • Frank Voisin

            Mistaken omission. Updated.