Market Commentary

What is a Value Investor

March 2014

"What is a cynic? One who knows the price of everything and the value of nothing." – Oscar Wilde

"Mama, the pennant is like money: it's actually worth nothing, but it means everything." – Sue's twelve-year old daughter Serena, on seeing the San Francisco Giants' 2010 World Series pennant for the first time

On many financial websites, the default price chart available for a stock is the intraday chart. This is a minute-by-minute chart of prices during a day the stock market is open. You have to dig a little to discover what's happened over more than a day. In this instance (though not for the first time) the considerable power of the internet has been applied to something we find pretty useless. This default pricing detail has always seemed a little ridiculous to us, and we've joked about the stress of not knowing what stock prices are on a Sunday between 10 am and 2 pm. The availability of exponentially more information about short-term price movements creates an incorrect overall emphasis on the short term in the investment arena. Clearly this is borne out by the short-term focus of an enormous quantity of high speed trading in our capital markets, where buys and sells of the same securities occur within fractions of a second and make up as much as half of the entire stock market trading in the U.S. [i]

Warren Buffett, the well-known value investor, has said, "I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years." While that seems a nonsensical at first, it's a statement about near-term price discovery being less important than finding value – and higher prices that come with it - over the long haul. If a value investor is going to own something of quality at a good price, this investor doesn't really need to know the price of everything every minute of every day. What's more important for the discipline of investing based on an understanding of long-term value is to create enough perspective to know what something may be actually worth once quality is persistent - and revealed.

So, what is a value investor? One who learns about the price and the value of things, and who is very interested in taking action when there is a mismatch between the two. In your portfolios, we have a particularly keen interest in how the managers we select for you come to assess the value of investments they make – after all, anyone can know their prices. To a team, your managers are interested in a determination about quality helping to define value. Quality is notoriously hard to define, and our managers do in-depth and on-the-ground research on the reality of each entity whose securities they believe may offer value – and have done so consistently and successfully over many years.

Some of the areas your managers emphasize in their research, whether focused on stocks or bonds, include:

• Steadiness and reliable growth of cash flow
• Defensive 'moats' around businesses and countries: pricing power, unique & sustainable competitive advantages & market share
• Financial strength and flexibility leading to long-term access to resources for growth in good times and survival in bad times
• The management team's or government's assessed openness, transparency, and skill at decision-making, particularly when it comes to allocating resources for the future

We've been busier in your portfolios lately, adding managers we feel can find value in specific areas of the market while they remain committed to quality. We've added selectively to bond positions where credit quality and risk has been carefully selected in higher-yielding names (though not exposing you to longer-term interest rate risk). We've also pulled back on currency risk, though you'll continue to be invested in countries that have high quality, shorter-duration credit and undervalued currencies.

The U.S. Federal Reserve's slowdown in bond purchases - the 'taper' - has led to opportunity overseas. There's been material weakness in markets overseas as cheap money that rushed into emerging markets following the financial crisis is now rushing out. The headlines in Russia and Ukraine have only added to stress in this arena. We agree with some of our managers that the term 'emerging markets' was coined for use in marketing investment products, and that there really only are specific companies in specific countries , and some of your managers are practiced at assessing value and quality all over the world. Some interesting opportunities have opened up in stocks overseas, where some investors have decided to sell quality down to attractive prices. This is a volatile space, and we agree with one of your managers who recently told us: 'volatility is not risk. Price is risk, and stocks that have sold off recently are less risky than they were before.' We proceed here incrementally and carefully. Put simply, we are interested finding those key mismatches where value is high, and price is low.

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.

[i] See research at http://www.world-exchanges.org/files/statistics/pdf/WFE_Understanding%20HFT_May%202013.pdf