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Fear, a value investor's worst travelling companion

When talking investments, the dread of losses is the worst enemy of value investors. Retreat is by no means cowardly, but it does mean the loss of a great opportunity to recoup expected returns.

25 · 10 · 2018
MIGUEL Portilla

3 minutes

In my 25 years as a value investor, I can certainly say that I’ve seen it all just like all those other old fogies. But it’s the truth. Markets have never been immune to the slight or extreme, yet nevertheless constant ups and downs such as the one reflected by Iván Mata’s illustration in this post. A roller coaster in which many lose the shirts off their backs by fleeing in terror from difficult moments.

This fear or dread of losing everything is actually logical and understandable when making irrational or unprofessional investments without having any proper understanding of finance and investing or when playing the stock market as if it were a game of Russian roulette with a position of “maybe the ball will land on our investment”.

On the other hand, escaping from rationally, judiciously and professionally made investments that are well-studied and diversified value investments will only mean that we’re about to lose out on a great opportunity to recoup all the expected returns.

These aren’t just pretty and reassuring words at a time when most investors are presently battening down the hatches to weather the vagaries of the market. I’m basing my opinion on facts and real figures as an investor, and I’d also like to remind the eldest ones amongst us in this regard, because our memories are very short when it comes to such matters. But I also want to impart this wisdom to newbie investors, because if they keep a sufficiently cool head to reckon with these temporary falls, they’ll see that it’s actually worth it not to hop off the train for fear of a crash. In fact, jumping from this train is worse because it could mean financial “suicide”.

While I’ve ridden several huge roller coasters in these past 25 years as an investor, two in particular were absolutely terrifying. The first was caused by the tech bubble, which is also referred to as the dot-com bubble. Most people lost their heads with Terra and similar companies. One day back in 2000, I even asked García Paramés personally why he wasn’t investing in Terra. At that time, everyone except us was lining their pockets. On a paper napkin, he drew four formulas that calculated this company’s maximum share value at 5 euros, though it was then listed at over 120 euros per share. It had even climbed as high as 157 euros, yet nevertheless plummeted to 3.04 euros on the day it finally closed.

While some indeed made a killing investing in that company, most investors lost a lot of money as they clung to a greed that could not be quenched by any real business rationale.

García Paramés maintained a nearly absolute wariness of most of these tech companies, so much so in fact that, as I recall, the funds he managed sustained losses of around 8% while the comparative index was soaring at around 18%.

At that time, I had friends and particularly co-workers who sallied forth from the value train to hitch a ride on the dot-com bandwagon. In the next three years, however, that market lost 40% and my train, which had been running against the grain or in a direction opposite the market trend, rose by 49%. A noticeable difference.

And this was achieved through shares in CAF, for instance, a rail industry company (since we’ve already mentioned trains), in which Paramés had been investing for some time. CAF was listing at 14 euros in 2000, and hit 440 euros ten years later. This is what I call high speed. Everything else is just a fairy tale.

Was that a stroke of luck? No, because CAF had also been investing in many other solid companies at paltry prices. The investment herd was stampeding only towards technologies but failed to see the enormous opportunities around them. This is the typical irrationality that often shakes up markets.

Investments that went against the market grain by targeting truly solid companies with clear businesses, solvent teams, etc., scored excellent returns for the few investors, ourselves included, who placed our trust in value management. Eventually the herd came back sooner or later, as investors returned to recognising and placing their trust and money into such investments.

However, when they begin to get crowded and the value rises above what value managers consider to be appropriate, this is the time to jump ship, which is exactly what they do to immediately invest in other well-managed, reliable yet undervalued companies that, yet again, the majority may be overlooking. While the investment may bear fruit as soon as one year or as long as five, most cases have proven their yield. Errors still exist, however, since everyone makes mistakes from time to time, but they are usually only slight because of the rigour with which these companies were analysed.

The real estate and financial crisis that began in August 2007 was the second huge investment roller coaster that I’ve ever ridden. During the first half of that year and the year before it, I lost count of how many friends and family members who began to invest, mesmerised by the returns that we were already raking in when entrusting our money to value managers. Some opted to avoid paying commissions by investing on their own as “champions” while many others opted into funds managed by banks, and only a few embarked on value investments.

I managed to convince some of my closest family members to trust in value investments and turn their backs once and for all on the path that their banks had taken. They did, though their legs began to tremble with the initial ups and downs of the stock market and, when the Lehman Brothers investment firm folded in September 2008, most ran for the hills in panic.

This was an understandable reaction from investors who were still fairly new to investing, because the falls were devastatingly steep. There were days in October that year in which falls were 10%. People abandoned their investments solely on the reasoning of not losing absolutely everything.

Seasoned veterans, however, placed our trust in our value investments. We grinned and bore a year with losses of 44% in the international fund and 35% in the national fund. Ultimately, the international portfolio loss no less than 62% until March 2009 (in 18 months).

What ended up happening? Everyone that had jumped ship from value investments lost out on the 100% climb in the ensuing nine months and onlookers waiting in the wings yet fearful of new falls also lost out on the subsequent substantial increases. Because it is very difficult to really anticipate the perfect moment to enter or exit.

One nugget of wisdom that has become very clear to me throughout these investment experiences, which is of course useful for every authentic value management regardless of the manager, is that whenever your economy permits, you should invest during steep falls and never jump ship unless absolutely required by your economic needs.

This sort of investment thinking will always bring you greater returns in the long term. However, if you’re just looking for short-term profits or doubt your ability to withstand a few months of falls, perhaps it’s not a good idea to enter value investing. Play Russian roulette or invest all your money in fixed income securities even though you might not be aware that your spending power is the least that you can lose.