With so much having changed in the financial world over the years, can decades-old investment strategies still work today? Validea CEO John P. Reese says they certainly can.
“I’ve seen first-hand how winning quantitative investment strategies can continue to work long after they’re well known and decades after they’re developed,” Reese writes for Advisor Perspectives. “Take the strategies of Benjamin Graham, the ‘Father of Value Investing’ and Warren Buffett’s mentor. I recently read a piece contending that Graham’s approaches can’t work in today’s environment because times are so different from when Graham managed money. The reasoning sounds logical – after all, there was no high-frequency trading back in Graham’s day, markets were far, far less global and the 401(k) and retirement-account investing that drive a lot of today’s equity purchases weren’t factors. Plus, certain variables can go in and out of fashion as investors develop new techniques for evaluating businesses and stocks. But my experience and testing show that successful strategies continue to work long after they are created and revealed. In fact, the ‘guru strategy’ I base on Graham’s Defensive Investor approach is one of the top-performing models on my research website despite the fact that Graham published it 65 years ago.”
Reese says there are a couple reasons that decades-old strategies can continue to work. One is that good strategies look at a variety of fundamental criteria that examine a stock from multiple angles. Second, he says, the numbers they look at aren’t some sort of magic formula — they measure real concepts that get at the core of good business and investing. “I’m not buying Graham-style stocks with stable earnings, more net current assets than long-term debt and low P/E and P/B ratios because I think that people will greatly value stocks with those qualities in a year or two. In fact, when I sell the shares, I hope the P/E and P/B ratios will be much higher. Instead, I’m buying them because those numbers tell a story about a company and its shares. Each variable plays a specific role, whether it be the information on a company’s balance sheet, the effectiveness of its management or the attractiveness of its share price.”
Theoretically, once a strategy is well known, it should stop working since — according to efficient market believers — the market discounts all known information. “But that assumes that humans are rational, and decades and decades of market history show that they are not,” Reese writes. “Most people, whether individual investors or professional fund managers, don’t buy stocks based on cold, hard fundamentals and financials. Instead they follow the crowd, try to capitalize on macroeconomic factors or base their decisions on their biased evaluations of a company’s products and services. And if they try to follow a fundamentally based strategy, they often end up ditching it as soon as it hits short-term problems (which any strategy will do), as they can’t take the emotional toll of staying the course when things aren’t going well.” All of that helps such strategies continue to exploit inefficiencies in the market.