Claudio Grass (CG): In this surreal policy environment, how has the role and the investment process of the value investor evolved, especially over the last decade? How can one still identify value in a world of subsidized binge borrowing, extreme indebtedness, and stock buybacks? (Click here for Part I of the interview)
Robert Mark (RM): The patriarch of value investing, Ben Graham, once said, “In the short run the market is a voting machine, but in the long run it is a weighing machine.” As markets have evolved into modern, global electronic exchanges, Graham’s analogy remains true. Short-term, stock markets are beauty pageants. Speculators continue to vote for the Wall Street darlings. On the other end sits the weighing machine which measures the future earnings of a business. As a value investor, my role is to focus on the weighing machine despite the party over at the voting machine. Binge borrowing, extreme indebtedness, and stock buybacks all feed into the emotions of the voting machine. Value does exist in certain pockets of the market, but one must simply step aside and operate at their own pace.
CG: Many mainstream analysts and commentators have rushed to declare value investing obsolete, especially following the recent losses suffered by value giant Warren Buffet. Could it be that the markets have become too distorted by central bank policies and by algorithms to identify value or is this assessment simply too simplistic and naive?
RM: Warren Buffett and his company Berkshire Hathaway have come in for criticism from those sitting in the bleacher seats—”too big, too slow, too old-fashioned”. Buffett had his worst performance versus the S&P 500 in 2019, and 2020 is looking just as bad. Instead of highlighting Berkshire’s fortress-like balance sheet, critics argue that Buffett needs to fundamentally rethink his mix of businesses and investments. Berkshire Hathaway’s cash position has increased to about $140 billion, but to the surprise of many, Buffett did not deploy any of that dry powder during the market’s plunge in March. He did not see “anything attractive.”
In short, yes-central bank policies, passive investing, algorithms, and any number of factors are distorting the markets and will continue to distort markets. We cannot choose the game to play, but we can play the game by our own rules. Buffett’s job is to remain focused on the weighing machine, not the voting machine… which is exactly what one would expect from a value investor. Buffett built Berkshire Hathaway to reward investors over time, but not on time. Investing always involves making decisions under uncertainty. We never know what the market will do in the near term, but value investors understand that if they vote for assets rather than patiently weighing their potential investments, they run the real risk of permanently destroying their investment capital.
CG: Aside from the obvious economic concerns, we’re also seeing a lot of turbulence in the geopolitical and social fronts, from US-China relations to internal social unrest in much of the western world. Do you see real risks there too and did you have to adjust your own investment approach to account for them?
RM: It boils down to three simple words: margin of safety. Our psychology is critical to the investment process. For example, if an investor loses confidence and has made too many mistakes recently, it becomes very easy to say, “I can’t stand being down more than this.” Therefore, we believe in being conservative all the time—by being both a patient buyer and a disciplined seller. If we do so, we ensure a margin of safety in our investments. We frequently reference another quote from Benjamin Graham in every presentation we make: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” We do not speculate, we invest. And when we invest, we demand a margin of safety.
Back in 2002, Secretary of Defense Donald Rumsfeld used the phrase “There are known unknowns and unknown unknowns” during a news briefing about the lack of evidence linking the government of Iraq with the supply of weapons of mass destruction to terrorist groups. A lot of people sort of scratched their head at these linguistic gymnastics. Known unknowns are risks you are aware of, while unknown unknowns are risks that come from situations that are so unexpected that they are not even considered. We always see very real risks when investing but try to account for these risks in the quality of the companies we select and the margin of safety we apply to our estimate of fair value.
CG: A lot has been said and written about the rally in precious metals and the reasons behind it. What do you think is driving it and what is your view on the role of gold in an investment portfolio?
RM: One can readily point to any number of reasons as to why gold is moving ‘higher’ over short periods of time, beginning with a loss of confidence in central banks or the soundness of one’s currency or negative real interest rates. However, we forget that over time, gold is not moving higher but rather our currencies are losing value against gold. Or at least that is how I view the situation. As for the role of gold in one’s investment portfolio, you are preaching to the choir. So yes, I absolutely believe in the value gold provides to one’s asset allocation. Personally, I first started buying physical gold in the summer of 2000, when I walked into a local jewelry store and asked the owner if he sold gold coins. He laughed and said that he did sell gold coins, but it had been about ten years since he last sold any coins. As a natural contrarian, I found the jeweler’s response interesting.
CG: In the last few years, we’ve witnessed the rise of the amateur investor, facilitated by popular apps and zero-commission brokers, and this trend was drastically accelerated during the lockdowns. Are you concerned about this wave of inexperienced investors entering the market en masse and making bets they don’t really understand, with money they can’t afford to lose? Do think this has the potential to have a wider impact on the markets?
RM: There is little doubt in my mind that the advent of Robinhood and zero commissions at the online brokerage firms like Charles Schwab has certainly generated a lot of excitement. A new generation of retail investors are at the voting booth and chasing the prettiest candidates that Wall Street has to offer. I watched in shocked amusement when a U.S. federal judge approved plans for bankrupt rental car company Hertz to sell $1 billion in stock AFTER the company filed for bankruptcy and HTZ stock increased tenfold. Another example that comes to mind was when a small Chinese real estate company in one day jumped 1300% on no news. The company’s name is Fangdd Network Group, which is similar to the popular acronym “FAANG,” representing Facebook, Apple, Amazon, Netflix, and Google. FAANG shares were up that day; therefore, I guess that a number of new traders somehow believed that Fangdd should trade higher as well.
I have no issue with new retail traders. In time, they will learn their own lessons and draw their own conclusions as to how one should best allocate their investment capital. The one group that I would single out are the professional “paid-to-play” active managers desperately trying to keep up with their respective benchmarks. I suspect that many are actively trading these FAANG names in order to catch up to their benchmark. One wonders if they really believe that they are doing the right thing for their clients or are they focusing on retaining and growing assets under management? These professional managers know the game: clients will fire them if they underperform their benchmark. Therefore, they constantly try to closely track their index, fearful of being too cautious in a rising market and straying from their target benchmark performance. I can understand the retail investor who is trading and taking risk with their own capital. I do not forgive the professional who knows better and yet goes ahead and puts his clients’ capital at great risk.
CG: Looking ahead, and given the uncertainty and the legitimate fears that are on many investors’ and ordinary savers’ minds, what would be your advice for those who wish to preserve and protect their wealth during this crisis?
RM: I suggest that one takes a serious look at the investment philosophy behind the ‘permanent portfolio’ allocation. Libertarian Harry Browne first proposed this concept in the book Fail Safe Investing. To summarize, the permanent portfolio is an investment portfolio designed to perform well in all economic conditions… Remember, there are unknown unknowns!
The permanent portfolio is composed of an equal allocation to stocks, bonds, gold and cash. Browne believed that a portfolio equally split between stocks, precious metals, government bonds and US Treasury bills would be an ideal investment mixture for investors seeking safety and growth. Browne argued that the portfolio mix would be profitable in all types of economic situations: stocks would prosper in expansionary markets, precious metals in inflationary markets, bonds in recessions and Treasury bills in depressions.
The biggest potential problem with this investment strategy is that sitting through long periods of underperformance can be very difficult, if not impossible… The price action in Tesla and Apple after they recently announced stock splits is far more exciting than rebalancing a simple asset mix each year. However, the goal of the strategy is not to outperform, but to generate long-term investment returns that exceed inflation while protecting your investment capital. To borrow an American baseball analogy, your likelihood of long-term success is far greater if you consistently hit singles rather than swing for homeruns.