Test­ing the phi­los­o­phy over time

History shows that a com­bined strat­egy of value and growth is the best ap­proach to in­vest­ing long-term

Financial Mail - Investors Monthly - - Guest Column - DAWID BOTHA Dawid Botha is a se­nior port­fo­lio man­ager at PSG Wealth Winelands.

The trick to a sound in­vest­ment phi­los­o­phy is to find a re­peat­able, sim­ple and proven process that greatly re­duces hu­man sub­jec­tiv­ity and bias.

This process must give you volatil­ity that is lower than the bench­mark, but with a high base rate of suc­cess.

It’s far more dif­fi­cult than you think. There are many eq­uity man­agers scat­tered around the world, all try­ing to beat Mr Mar­ket (the World In­dex) or a coun­try in­dex, typ­i­cally from one of two schools: “value” in­vestors or “growth” in­vestors.

Of course, even those from the same school get dif­fer­ent re­sults. Port­fo­lio man­agers of­ten ap­ply their process in­con­sis­tently be­cause they are, af­ter all, hu­man be­ings who of­ten act dif­fer­ently from how they think they should. This has opened the door to the fas­ci­nat­ing field of be­havioural fi­nance, which has ex­ploded many in­vest­ment myths.

Hu­man be­ings shouldn’t chas­tise them­selves for ir­ra­tional­ity, of course.

Sir Isaac New­ton, the fa­ther of physics, was suck­ered into in­vest­ing in one of the ear­li­est recorded bub­bles, the South Sea Trad­ing Com­pany. Twice, New­ton bought and sold shares over an 18-month pe­riod, be­fore selling out and clock­ing up a £20 000 loss. Now this hap­pened in the 1720s to a ra­tio­nal, in­tel­lec­tu­ally gifted hu­man be­ing.

But, as Von Goethe once said: “To think is easy, to act is dif­fi­cult. To act as one thinks is the most dif­fi­cult of all.”

It’s true also that in­vest­ment styles go in and out of favour. Growth in­vestors can out­per­form value in­vestors for long pe­ri­ods of time and vice versa. The thing is not to panic.

Another fact is that, given the rea­son­able ef­fi­ciency of the mar­ket, it is quite rare for man­agers to out­per­form Mr Mar­ket over the longer term.

It is recog­nis­ing this fact that has pushed large funds into tracker funds or ETFs. The prob­lem with tracker funds, the way I see it, is that the in­vestor as­sumes all the mar­ket risk. A bet­ter way to do it is mea­sure the volatil­ity of the mar­ket and man­age it, so an in­di­vid­ual port­fo­lio car­ries less mar­ket risk than the bench­mark.

How do you find an in­vest­ment strat­egy that nav­i­gates around all these vari­ables?

Af­ter much search­ing, I found one US fund man­age­ment house that had tested nu­mer­ous strate­gies over more than 75 years, com­pil­ing a data set that con­sid­ered all the sta­tis­ti­cal pit­falls like data min­ing, the look-ahead bias, sur­vivor­ship bias and other pit­falls. Over that pe­riod of time, all the value and growth strate­gies would have been tested.

The con­clu­sion was that a com­bi­na­tion of the fun­da­men­tal (value) and mo­men­tum (growth) in­vest­ment strate­gies pro­vided the best risk-ad­justed re­turns. Both the undi­luted “deep value” strat­egy and the “go with the flow” mo­men­tum strat­egy came short at some stage.

It’s a strat­egy I’ve ap­plied since 2006 to a port­fo­lio of global eq­ui­ties. The base rate of 85% this pro­duced meant that, 85% of the time, the re­turns beat the mar­ket, in­clud­ing over 10-year rolling pe­ri­ods. As it stands to­day, US stocks make up roughly 55% of my port­fo­lio, which con­tains about 50 global stocks.

In the US, the health sec­tor is con­sid­ered sexy right now.

The stock in this port­fo­lio which I be­lieve fits the cri­te­ria of the com­bined strat­egy is called Gilead Sciences.

Gilead is a re­search-based bio­phar­ma­ceu­ti­cal com­pany, listed on the Nas­daq, which earned about half of its $25bn rev­enue in 2014 from treat­ments re­lated to chronic hep­ati­tis C.

To­day, it has a mar­ket cap of $171bn, is trad­ing at a price-to-earn­ings ra­tio of 12 and a price-to-cash flow ra­tio of 10, and de­liv­ers a div­i­dend yield of 1,5%.

To my mind, Gilead trumps other phar­ma­ceu­ti­cal com­pa­nies — like Cel­gene, Eli Lilly and Bristol-My­ers Squibb — which ap­pear to be in a price bub­ble or an in­trin­sic eco­nomic bub­ble.

There is, of course, a health warn­ing: shares like Gilead are for the long term (10 years plus). Eq­uity mar­kets, as the last 75 years il­lus­trate, can be volatile over the short term.

To my mind, Gilead trumps other phar­ma­ceu­ti­cal com­pa­nies

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