Is War­ren Buf­fett wrong? Does ‘buy and hold’ still have a place? IN­SIGHT

Finweek English Edition - - Insight -

IS WAR­REN BUF­FETT’S “buy and hold” in­vest­ment phi­los­o­phy past its sell-by date? Even ask­ing the ques­tion is taboo in some cir­cles – a bit like men­tion­ing Charles Dar­win’s the­o­ries about evo­lu­tion in the po­lite draw­ing room so­ci­ety of Vic­to­rian Eng­land or sug­gest­ing circa 1630 in the Sis­tine Chapel that just per­haps the nice Mr Galileo may have a point about the earth not be­ing the cen­tre of the uni­verse. Ques­tion­ing the rel­e­vance of buy-and-hold in­vest­ing – the style that’s made Buf­fett one of the world’s rich­est men – is bound to draw crit­i­cism.

Buf­fett’s ba­sic phi­los­o­phy is de­cep­tively sim­ple: Buy qual­ity com­pa­nies that you’d like to own out­right at sen­si­ble val­u­a­tions and hold them over time as they de­velop and grow.

How­ever, the world has changed and the bl­o­go­sphere is lit­tered with com­men­tary on how in­vestors need to take a more ac­tive in­vest­ment ap­proach – in­vest­ing through cy­cles rather than pur­su­ing a pure value ap­proach – which im­plies long-term in­vest­ment.

“Eq­uity was al­ways buy and hold: it didn’t mat­ter when you bought – you al­ways made money if you held for more than five to 10 years. It was about time in the mar­ket rather than tim­ing the mar­ket that was im­por­tant,” says RMB As­set Man­age­ment port­fo­lio man­ager Wayne McCur­rie, re­flect­ing the clear mer­its of the Buf­fett phi­los­o­phy of buy­ing qual­ity com­pa­nies cheaply and en­joy­ing the re­turns. But he says in­vestors who want to gen­er­ate con­sis­tent re­turns over time will need to be more ac­tive in the way they man­age their port­fo­lios.

“The sever­ity of the fi­nan­cial cri­sis has ex­posed some of the in­her­ent lim­i­ta­tions of buy and hold over ac­tive man­age­ment,” says Vic­tor Mpha­phuli, se­nior port­fo­lio man­ager at Stan­lib. “The truth is that bear mar­kets – es­pe­cially in pe­ri­ods of cri­sis – are ruth­less and dif­fi­cult to pre­dict and gains built up over years were wiped out in a mat­ter of months,” he says, point­ing to the fact that volatil­ity is go­ing to be a fea­ture of mar­kets for the fore­see­able fu­ture.

The grow­ing com­pe­ti­tion be­tween fund man­agers con­stantly on the look­out for out­per­for­mance in their never-end­ing strug­gle to at­tract new funds also means pri­vate in­vestors need to be­come more in­no­va­tive.

“Con­di­tions are far more com­pet­i­tive out there in the in­vest­ment and sav­ings in­dus­try,” says Fran­cois van Wyk, chief in­vest­ment of­fi­cer at Cadiz As­set Man­age­ment. “The new land­scape has in­tro­duced the ne­ces­sity to con­sis­tently out­per­form oth­ers in or­der to at­tract money.”

The idea of manag­ing your own port­fo­lio has nu­mer­ous at­trac­tions, in­clud­ing the fact you aren’t pay­ing man­age­ment fees to a third party to make in­vest­ment de­ci­sions on your be­half. How­ever, as a pri­vate in­vestor, if you aren’t out­per­form­ing SA’s top fund man­agers you should prob­a­bly be giv­ing them your cash any­way. The chal­lenge pri­vate in­vestors face is that they need to con­stantly an­tic­i­pate the trends the in­vest­ment in­dus­try is fol­low­ing. That sort of ac­tiv­ity comes with a se­vere health warn­ing.

“The idea of tim­ing the mar­ket is cer­tainly ap­peal­ing. How­ever, the re­al­ity is most in­vestors when in­vest­ing their own money will make emo­tional de­ci­sions, re­sult­ing in their mak­ing the wrong call and ul­ti­mately los­ing money,” says Jeremy Gar­diner, di­rec­tor at In­vestec As­set Man­age­ment.

The em­pha­sis is a sub­tle shift in in­vest­ment ap­proach that re­quires in­vestors to be thor­oughly cog­nisant of the ex­tra­ne­ous fac­tors that im­pact their in­vest­ment de­ci­sions. A man­u­fac­turer of wooden wagon wheels in 1916 may have ap­peared cheap but the in­dus­try was about to be over­taken by the man­u­fac­tur­ers of vul­can­ised rub­ber. Nim­ble in­vestors would have spot­ted the change and adapted ac­cord­ingly.

Then there are the leg­endary sto­ries of Stel­len­bosch farm­ers who sup­ported a young An­ton Ru­pert when he came knock­ing on their doors seek­ing cap­i­tal in the early part of the last cen­tury. In­vestors in the orig­i­nal Rem­brandt Group have seen con­sid­er­able re­turns. mag­a­zine re­cently high­lighted the ben­e­fits of longterm buy and hold strate­gies in a com­pany such as John­son & John­son, which listed in 1944 at US$37,50. With div­i­dends rein­vested in the stock over time that stake would cur­rently be worth around $900 000

and de­liv­er­ing around $34 000/year in div­i­dends.

The ar­ti­cle con­tin­ues: “Even if you hadn’t rein­vested the div­i­dends, that sin­gle share would now be 2 500 shares, as a re­sult of splits, and you’d be col­lect­ing $4 500/ year as a re­sult of that $37,50 in­vest­ment. If only Grandpa had bought 100 shares.” It’s hard to ar­gue against that logic.

The re­al­ity for or­di­nary in­vestors, par­tic­u­larly in US eq­ui­ties, says McCur­rie, is that they’ve ef­fec­tively de­liv­ered a zero re­turn over the past decade. The real bull mar­ket, he ar­gues, started in the early Eight­ies as the in­fla­tion­ary Sev­en­ties were left in its wake and lasted un­til the dot com bust in the early Nineties.

That bull mar­ket was driven by a sig­nif­i­cant drop in the dis­count rate when the US gov­ern­ment bond fell from 15% to 5% and earn­ings growth blos­somed. Earn­ings grew at an av­er­age 6,3% com­pounded, while the mar­ket ran ahead of 12%/year. That phe­nom­e­non, McCur­rie says, is over – due to the fact US bond rates can’t fall that dra­mat­i­cally again.

An­other key fac­tor for in­vestors to con­sider is that the high lev­els of con­sumer debt that fu­elled the last boom are also un­likely to be re­peated. De­spite that, McCur­rie re­mains op­ti­mistic eq­ui­ties will con­tinue to out­per­form other as­set classes – al­beit that out­per­for­mance is likely to be much smaller than it was pre­vi­ously.

Ac­tive pri­vate in­vestors also need to be aware of the tax con­se­quences their strat­egy might bring to bear. The SA Rev­enue Ser­vice has been quick to clas­sify ac­tive pri­vate in­vestors as traders in the past and that’s meant each trade has a tax con­se­quence for those who reg­u­larly en­ter and exit po­si­tions in the mar­ket.

VIC­TOR MPHA­PHULI In­her­ent lim­i­ta­tions

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