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