In 1984, Hermes, the Columbia Business School magazine, published an article by Warren Buffett titled “The Superinvestors of Graham-and-Doddsville”. The piece was based on a speech he gave at the school to mark the 50th anniversary of the publication of Benjamin Graham and David Dodd’s Security Analysis, and opened with the question: is the Graham and Dodd “look for values with a significant margin of safety relative to prices” approach to security analysis out of date?
What followed was Buffett’s rejection of the academic view that the stock market is efficient – that stock prices reflect everything that is known about a company’s prospects and about the state of the economy – and that, therefore, there are no undervalued stocks.
“Well, maybe,” wrote Buffett. “But I want to present to you a group of investors who have, year in and year out, beaten the Standard & Poor’s 500 stock index. The hypothesis that they do this by pure chance is at least worth examining … In this group of successful investors that I want to consider, there has been a common intellectual patriarch, Ben Graham. But the children who left the house of this intellectual patriarch have called their ‘flips’ in different ways. They have gone to different places and bought and sold different stocks and companies, yet they have had a combined record that simply can’t be explained by random chance … The common intellectual theme of these investors is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market. Essentially, they exploit those discrepancies.”
The group Buffett was referring to comprised Walter Schloss, Tom Knapp (who founded Tweedy Browne), Charlie Munger (who joined Buffett at Berkshire), Bill Ruane (who launched the Sequoia Fund) Stan Perlmeter and Rick Guerin. Collectively, they’ve come to be known as the Superinvestors.
What’s remarkable is their investment ability. Schloss managed to return 21.3% annually for 29 years during a period in which the S&P returned only 8.4% per year. Knapp, along with partner Ed Anderson, returned 20% for 15 years during a period where the S&P 500 returned only 7% per year. Perlmeter, a liberal arts graduate with little interest in securities, generated returns of 23% per year.
What Buffett didn’t mention was their short-term performance. Guerin’s incredible run – outperforming by 23% per annum over 19 years – included a six-year streak of consecutive underperformance in which he fell behind by a cumulative 70%. Ruane fell 40% behind in his first three years. Schloss subsequently fell behind from 1989 to 1999.
In a follow-up paper to Buffett’s article V Eugene Shahan showed that these managers underperformed in 30% to 40% of the years covered. “If these returns were recorded at a typical investment firm,” he asks, “would any of these people still be money managers? In a world in which fund consultants reallocate assets to [or from] managers based on their performance over the last 12 months, would any of them let clients stay on?
“I assume that none of these managers panicked in the face of adversity and changed his style after three disappointing years of using a value approach,” says Shahan. “But how many investors have the strength of character to continue an approach that can be unrewarding for three or even five years? Isn’t it easier, after a miserable one or two years, to grab at the things that are moving, that other managers who are doing well are holding, that you feel foolish for having missed?”
By way of an answer, Barron’s reported early in 2018 that for seven of the past 11 years value stocks, and many of the people who own them, have languished. “It’s getting tiresome,” said the magazine, “even for those famous for their patience … legendary value investor Warren Buffett started building an Apple stake in early 2016. Others seem to be broadening the definition of value investing. Some justify owning Amazon or Netflix by arguing that they remain undervalued by the broader market … John Rogers Jnr, founder of the $13bn value fund shop Ariel Investments, laments value’s challenges but, ultimately, has decided it’s best to just stay disciplined and patient.”
Could that be a mistake? “Is value dead?” asks Barron’s. The short answer: not by a long shot.
“If the market gets out of its Goldilocks stage and the economy gets hotter, or the markets get colder — either way, value will work,” says Scott Opsal, research director at Leuthold Group. But whereas in the past investors could just be very disciplined and stay clear of the glamour stocks and bubbles and ‘buy the ugly’, that’s changed. It has gotten harder,” says Bruce Greenwald, co-director of the Heilbrunn Center for Graham & Dodd Investing at Columbia Business School.
“I think late-cycle problems are part of it because everything looks overvalued,” says Greenwald.
“But there is also a very specific problem that I think has to do with this transition in the economy from manufacturing to services. Services are local businesses, local businesses mean small markets, and small markets mean more dominance… as a result, they’re more profitable even with less investment. Value investors will pay for today’s profits, but they’re very nervous about paying for future profit growth ...
“The other thing is, especially in the US, we have just produced a lot more value investors. The fact that Buffett is so prominent now means people are just better. If you put those three factors together, the environment is tougher.”
Still, after broad underperformance for most of 2018, as measured by the iShares Russell 1000 Value ETF and iShares Russell 1000 Growth fund, value stocks outpaced growth stocks last month.
As to what became of the Superinvestors in more recent times, it’s hard to find any information on Perlmeter and Guerin after 1984. Likewise on the investment performance of Knapp, who was with Tweedy Browne until 1986 and died in 2011 at age 90. Ruane continued to beat the market by more than 2% after 1983 until his death in 2005. Schloss, who managed to beat the S&P 500 by around 1% after 1984, closed his fund in 2000 and stopped managing other people’s money in 2003. He died aged 95 in 2012.
The performance of Buffett and Munger at Berkshire has become legendary, but despite his enormous popularity with the mainstream media Buffett remains rarely cited within traditional academia. According to Wikipedia, a significant share of references simply rebut his statements or reduce his own success to pure luck and probability theory.
William F Sharpe called him “a three-sigma event” (1 in 370); Michael Lewis “a big winner produced by a random game”.
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