Value investing still delivers

Stocktake:The basics of value investing are well known, dating back to Benjamin Graham in the 1930s. Far from being dated, however, Graham's principles continue to deliver stellar returns, according to investment manager Tobias Carlisle.

Carlisle (see greenbackd.com) notes that Graham tweaked his ideas towards the end of his life, proposing a less elaborate approach to investing, namely: create a portfolio of at least 30 stocks with price-earnings ratios below 10 and debt-to-equity ratios below 50 per cent. Hold these stocks until they return 50 per cent or else sell within two years.

Over the previous 50 years, Graham said, returns averaged 15 per cent a year.

Stock screens are more sophisticated these days, but it still works.

In his new book, Quantitative Value, Carlisle notes that the strategy would have returned 18 per cent annually between 1976 and 2011, compared to 11 per cent for the SP 500.

Bearish outlook for the year

Japan’s Nikkei soared 23 per cent in 2012, with almost all of those gains coming in the last six weeks of the year.

Famously bearish Swiss hedge fund manager Felix Zulauf, who predicted the global financial crisis, reckons the index has “at least another 20 per cent upside” in 2013.

The Nikkei bull market “could do more and last longer”, Zulauf said last week. “Nobody owns Japanese stocks,” he added, noting that the market was 75 per cent below its 1989 peak.

Zulauf, who also called the recent bottom in the Chinese market, argued that the Shanghai index also has “another 20 per cent to go”.

However, Zulauf’s bearish macro outlook remains unchanged. The current market “honeymoon” will end in mid-2013 or 2014 as investors realise the “improving fundamentals” are a mirage; the commodity boom is over, the current uptrend is “temporary and more for traders, not investors”.

And while the euro may yet hit $1.40, it will collapse to $1 next year “when the markets see more trouble and yields rise again on the sovereign debt of the peripheral countries”.

Fiscal cliff relief may yet prove fleeting

“The world is overbought,” Bespoke Investment Group noted last week, with 25 of 30 national indices in technically overbought territory.

In the US, 90 per cent of stocks were trading above their 50-day average, the highest percentage in 15 months.

The gains have been accompanied by a collapse in volatility. The Vix, or fear index, fell by 39 per cent in a single week, the largest fall since its launch in 1990.

Bespoke found nine previous cases where volatility fell by 30 per cent or more over a five-day period, with small market declines typically following over the following one-month and three-month periods.

Volatility had risen considerably in the weeks preceding the fiscal cliff deal. Market relief may yet prove fleeting, given that the problem has been postponed, not resolved. That the Vix is now below 14 – its lowest level since 2007 – indicates investor complacency, bears suggest.

However, while the stats may suggest a near-term consolidation, a low Vix in itself is not a warning signal. The Vix traded around current levels from 1992 through 1995 and again, throughout 2005 and 2006.

Hedge funds under pressure

“Hedge fund porn” and the “hedge fund version of Stalingrad” is how money manager John Hempton describes Wall Street’s battle over controversial nutritional company Herbalife.

Last month, billionaire trader Bill Ackman announced he had a $1 billion short bet against Herbalife, a multi-level marketing firm that he described as a pyramid scheme that would collapse or be shut down by authorities.

Last week, however, Ackman’s billionaire friend Daniel Loeb bought 8.2 per cent of the company.

Hempton, one of the best bloggers in the financial industry ( brontecapital.blogspot.ie), is a famous fraud-spotter and short seller. He describes Herbalife as "scumbags", saying the company "is mostly about ripping off distributors and people at the end of the chain".

So he’s short? No – he’s long Herbalife, saying they are “highly cash-flow positive scumbags and they will use the cash flow to buy back shares” .

It’s a novel take. With Herbalife up by more than 50 per cent since late December, it may also be a profitable one.

Last year was another awful one for hedge funds. The HFRX Global Hedge Fund Index rose just 3.5 per cent, despite almost every major stock index enjoying double-digit returns.

Such under-performance has become an annual event. Anyone with a conventional 60-40 portfolio (60 per cent stocks, 40 per cent bonds) would have almost doubled their money over the last decade, compared to the hedge fund index’s 17 per cent return.

With stats like that, hedge fund fees – typically 2 per cent of assets and 20 per cent of profits – will surely come under the microscope in coming years.