In his latest Q4 2021 Earnings Call, Rich Pzena discusses the danger of becoming anchored in investing. Here’s an excerpt from the call:
If a client asked me as 2009 began, just after the peak of the global financial crisis, what I thought our strategy would earn over the next 13 years. I would have and often did, express that I expected long-term returns to be in the low-double digits. And as we sit here today, 13 years later, our large cap, US large cap focused value strategy earned approximately 13.5% per year gross. So it seems we could fairly state, we achieved our expectations.
And yet the post GFC era is known now as the anti-value period. The period where growth strategies outstripped value strategies buy record levels, and for a record period of time. Many have question whether value investing even works anymore, or whether this time is actually different.
I’ve long been a fan of behavioral economists Daniel Kahneman and Amos Tversky. In the 1974 paper, they described the human tendency to bias their decisions due to a force they called anchoring. Kahneman and Tversky found that even arbitrary numbers could lead participants to make incorrect estimates. In one example, participants spun a wheel, to select a number between zero and 100. The volunteers were then asked to adjust that number up or down to indicate how many African countries were in the US. Those who spawn a high number gave higher estimates while those who spawn a low number gave lower estimate.
In each case, the participants were using that initial number from the wheel as their anchor point to base their decision. How does this tendency impact investors, investors are confronted with a myriad of investment choices to allocate their assets, always aim to achieve what they believe is their optimal outcome for the future and yet investors just like the participants in the wheel spinning exercise, are prone to biased decision making due to anchoring?
While our strategies generated 13.5% returns, which is nearly 100 basis points ahead of the Russell 1000 value index. The Russell 1000 growth index earned just under 19.5% per year for the same post GFC period. But in terms of absolute dollars, an extra 600 basis points per year for 13 years resulted in a growth index portfolio nearly double the size of a portfolio invested in our strategies.
But as history and that’s the saying goes past performance does not guarantee future results. Of course, I don’t know what the future will bring. I do, however, recognize the danger of becoming anchored in the last 13 years estimates, to estimate last 13 years to estimate the most likely outcome for the next period. I also know that the cheapest segment of stocks continues to sell on average for the same multiples of earnings that they have for the last 70 years. While the most expensive segment of stocks sells for the highest multiples ever recorded.
I know that the earnings yield on the cheapest stocks, averages in the low teens, while expensive stocks offer earnings yields of 2%. I know that even in a world of supply chain disruptions, disruptive technologies, love affair with cryptocurrency that buying a portfolio of good businesses selling for low prices give investors an outstanding opportunity to earn attractive long-term returns today, as it has consistently in the past.
You can read the entire earnings call here:
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