Seth Klarman – Beware of Value Pretenders

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With so many articles dedicated to the debate on value stocks vs growth stocks I think it’s a good time to revisit what Seth Klarman calls ‘Value Pretenders’ in his best-selling book, Margin of Safety.

Here’s an excerpt from that book:

“Value investing” is one of the most overused and inconsistently applied terms in the investment business. A broad range of strategies make use of value investing as a pseudonym.

Many have little or nothing to do with the philosophy of investing originally espoused by Graham. The misuse of the value label accelerated in the mid-1980s in the wake of increasing publicity given to the long-term successes of true value investors such as Buffett at Berkshire Hathaway, Inc., Michael Price and the late Max L. Heine at Mutual Series Fund, Inc., and William Ruane and Richard Cunniff at the Sequoia Fund, Inc., among others. Their results attracted a great many “value pretenders,” investment chameleons who frequently change strategies in order to attract funds to manage.

These value pretenders are not true value investors, disciplined craftspeople who understand and accept the wisdom of the value approach. Rather they are charlatans who violate the conservative dictates of value investing, using inflated business valuations, overpaying for securities, and failing to achieve a margin of safety for their clients. These investors, despite (or perhaps as a direct result of) their imprudence, are able to achieve good investment results in times of rising markets.

During the latter half of the 1980s, value pretenders gained widespread acceptance, earning high, even spectacular, returns. Many of them benefitted from the overstated private-market values that were prevalent during those years; when business valuations returned to historical levels in 1990, however, most value pretenders suffered substantial losses.

To some extent value, like beauty, is in the eye of the beholder; virtually any security may appear to be a bargain to someone. It is hard to prove an overly optimistic investor wrong in the short run since value is not precisely measurable and since stocks can remain overvalued for a long time.

Accordingly, the buyer of virtually any security can claim to be a value investor at least for a while. Ironically, many true value investors fell into disfavor during the late 1980s. As they avoided participating in the fully valued and overvalued securities that the value pretenders claimed to be bargains, many of them temporarily underperformed the results achieved by the value pretenders. The most conservative were actually criticized for their “excessive” caution, prudence that proved well founded in 1990.

Even today many of the value pretenders have not been defrocked of their value-investor mantle. There were many articles in financial periodicals chronicling the poor investment results posted by many so-called value investors in 1990. The top of the list, needless to say, was dominated by value pretenders.

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