One of the hardest things to get right as an investor is cutting the emotion out of your investment behaviour; it’s just too easy to get swept up in the market’s emotional highs and lows and to let those dictate your choices. But the world’s best investors, Warren Buffett among them, recommend emotionally detached investment strategies based on value and fundamentals.
Of course, this is easier to say than it is to do, but as Old Mutual’s Craig Chambers argues, one way to ensure that you do this is to make use of professional managers and index funds that take the emotion out of investing. An index fund will simply and cheaply track the performance of a given index, and a managed fund, like a unit trust, will allow a professional fund manager to make your stock buying and selling decisions for you. It’s one way to make rational choices despite your emotional urges. – FD
ALEC HOGG: Warren Buffett’s investment track record for mostly not being matched for years to come but, similar to his investment style, is fundamental indexation. Craig Chambers is Managing Director of Old Mutual Global Index Trackers and he’s in Cape Town, joining us for more. Craig, good to have you on air here with us today. I liked the report that you put together. You started off talking about what you call ‘emotionally detached investments’, something that Warren Buffett is brilliant at. We then went into four different stocks that we need to pay attention to, but let me just start off with that first point of Buffett’s ability to detach himself, emotionally, to look at things rationally, clinically, and logically, rather than the rest of us, who seem to be swayed by the way the wind is blowing.
CRAIG CHAMBERS: Afternoon Alec. I thought you’d enjoy the piece because I know you are very passionate about Warren Buffett. I think the main thing we’re trying to convey to our investors, is that the fundamental indexation approach that we use in our RAFI All World Fund is very much a quantitative methodical approach to investing. This just means that it is similar to Buffett’s emotionally detached process where he almost hovers above his investment once he’s made the call and isn’t really too worried about what people think about it. The RAFI approach is therefore very much a contra trading approach, looking to buy into counters that are out of favour and selling counters that have run too hard.
ALEC HOGG: And just to continue on the Buffett theme, Bank of America is one of the four stocks that you mentioned in your newsletter. That’s the one that he’s got an option to buy $5bn worth of stock or he’ll pay five billion, and the market value of those shares right now is #12bn, so he’s well in the money there. You still think that there’s an upside in this stock.
CRAIG CHAMBERS: Yes, it’s a great example because as of the March rebalance balance of RAFI, it was its second largest overweight position. It had a substantial overweight in Bank of America, as a result of the massive hit that that counter had taken on the back of the financial crisis. The way RAFI looked at it is that it was still a great business. It has 5000 branches servicing mainstream, America, so the business case is very much still intact. The new CEO, a guy named Brian Monahan, came in and he’s radically cleaned the balance sheet out and paid out the claims – 40 billion to date. What RAFI saw – and clearly, that is what Buffett anticipated as well – is that the market just overreacted. There was just too much fear there. They headed for the exits. The counter went down by over 60 percent after the 2008 crack, on the back of a financial acquisition called Countrywide Financial Services, just brimming with toxic debt. As a result, RAFI took a big overweight and from the bottom, it’s up 277 percent. My view is and certainly, RAFI’s view is that it’s still overweight US Banks and there are still lots of upside in that sector.
ALEC HOGG: And that’s the one to go for, rather than the other one Buffett’s been buying (Wells Fargo). Moving onto another out of favour stock, or certainly it was, British Petroleum, BP, another of your four.
CRAIG CHAMBERS: Exactly, so this one is still in a significant overweight position in the fund and, again, what the indexation model here – the Fundamental Tracker – has looked at is a once off exogenous event, deep water horizon happened. It really hit that stock. That stock was down 50 percent in four months on the back of that event, and investors were right in that the claims that have come through there, have also been substantial. Well over $42bn have been paid to date, but is the world’s sensational appetite for oil still intact? Absolutely, BP has actually just increased the dividend by 11 percent. The div yield on that stock is four-and-a-half percent, against real yields in the global environment of almost nil. It therefore remains overweight to that counter on the back of substantial cash, dividends, sales, and book value, which is what RAFI uses to determine the value of a company by just completely ignoring a share price.
ALEC HOGG: Two down, two to go, Nestlé is another one that came up very strongly. We know it’s a big investment into the African continent, this Swiss company. Why is it attracting so much of your attention?
CRAIG CHAMBERS: This is the opposite scenario to BP and Bank of America. RAFI has taken an underweight position to Nestlé and, again, it’s a contra trading approach, so after the 2008 crack when even Nestlé was down, guys really started to pile into those multi-nationals because of their defensive nature. However, the irony of a defensive stock is once it gets to a certain multiple, it’s no longer defensive and in fact, it’s the largest food company now in the world and their 2013 results were tepid. They were soggy at best: up five percent and really, RAFI’s view is that when you have a counter on a high multiple, it’s about a 20 forward. If you disappoint the market in any way and analysts start to downgrade your earnings, you would tend to get quite a big hit on the share price, so RAFI’s view is that the counters run too hard. It is no longer defensive. It’s a great company but not necessarily a great stock.
ALEC HOGG: And I was very distressed to see that you make a similar story for Apple. Many of us have read the Steve Jobs’ biography and take tips from the way that he built the business. Of course, it’s the late Steve Jobs today, and if I read you correctly, that’s playing a little part in the thinking, too.
CRAIG CHAMBERS: Exactly, so I think the important thing is that RAFI doesn’t necessarily always get it right. It will always look for value and if a company runs extremely hard for a long period of time, which Apple did from 2004 to its high in 2011… In fact, it was up 37.8 times, which is just phenomenal. What RAFI will keep doing every year when it does its annual recalibration of the four factors, is it will constantly cut back on those counters that are run very hard. However, if the company continues to exhibit substantial growth and the market continues to favour it then RAFI will tend to lag, so I think the point is that it wants to try to get it right more than it gets it wrong, within the 3000 stock, RAFI All World Portfolio that we manage. In the case of RAFI, it’s taken a substantial underweight position to the counter and in fact, in the last 18 months its growth hasn’t been great as well. Samsung is eating its lunch in the mobile phone market. In fact, its handset sales or Smart-set sales for Samsung were up about 300 percent or so, whereas Apple’s were hardly up at all. Samsung is now selling 300 million handsets, as opposed to Apple’s 150, so there are clearly competitors out there making inroads, and without the Steve Jobs’ effect creating the next disruptive industry potentially, Apple may not be exhibiting the kind of growth that it has in the past.
ALEC HOGG: Wonderful stuff, Craig, thanks for sharing those insights on the RAFI rebalancing and just to summarise it all. Bank of America and BP, the two stocks that you should be looking at to take a tip, a bit of coat tailing from RAFI, from their experts and Craig Chambers as well. Two stocks that perhaps can be down-weighted in your own portfolio, if you do own them, are Apple and Nestlé. That was Craig Chambers, who is Managing Director of Old Mutual Global Index Trackers and remember, you can email us on [email protected].
