C&B Notes

There Is No Free Lunch

In the wake of late 2008 and early 2009, the fear of volatility — particularly a large drawdown — is a highly influential lens through which many investors view the world.  As Jason Zweig writes, the money management industry has responded by promoting the benefits of market timing, which it is delivering in the form of an expanded roster of so-called tactical funds.  As value investors, we invert this approach:  we research heavily from the bottom up to identify great businesses and then look for market dislocations to build our stakes in these companies at depressed prices.

“People really do believe that tactical will save them,” says Robert Martorana, a financial adviser at Right Blend Investing in Hillsborough, N.J., who recently prepared a report on “alternative investments” (including tactical funds) for Financial Research Corp. of Boston.  “They think that [such funds] will provide absolute  returns in any market environment.  But that’s deeply problematic.”

It makes intuitive sense that a trained expert should be able to shield your assets from a further decline in the stock market.  Tactical managers aim to get out of stocks when stocks are going down and get back into them when they are going up. How hard could that be?  In fact, you’d have a hard time finding a more hapless bunch of wrong-way Corrigans than professional fund managers.  Data from the Investment Company Institute show that funds have an uncanny tendency to cut their exposure to stocks just as the stock market is about to take off — and then to pile back into stocks right before the market crashes.

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Of course, such great investors as John Maynard Keynes, Benjamin Graham and Warren Buffett owe at least part of their reputations to well-timed decisions to scale back their exposure to stocks.

But it’s worth noting that these revered investors didn’t get out of stocks when stocks were going down; they got out when stocks went up.  In other words, great investors like Graham and Buffett did the exact opposite of what the typical tactical fund purports to do.

That’s because they understood that when an asset gets cheaper you should like it more, and when it gets more expensive you should like it less.  Otherwise, as the great value investor Shelby Davis once told me, you end up pulling the flowers and watering the weeds.