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Shots Fired Against the Efficient Market Hypothesis
In 1984, Warren Buffett gave a speech at the Columbia University School of Business, Benjamin Graham's alma mater, commemorating the 50th anniversary of Graham's legendary Security Analysis, cowritten with David Dodd all the way back in 1934. Buffett later turned this speech into an article (it is highly recommended reading for anyone interested in value investing).
In the speech and article, he takes on the efficient market hypothesis—a theory that ultimately concludes that trying to beat the market is futile since all available information is out there for everyone to see, and everyone is rational and self-interested.
Buffett points to nine funds whose managers have, in fact, beaten the market consistently over long stretches of time, including one of his own Buffett Partnership Limited portfolio, calling attention to specific accomplishments of the investors. His firm conclusion? If you practice Graham and Dodd-style value investing, you can, in fact, beat the market.
This article calls attention to three market-beating 21st-century superinvestors, all of whom do some version of value investing, and all of whom have destroyed the market with their excellent track records. Perhaps more importantly, each of these masters of their craft is willing to share their wisdom with us. Here are some of their most important lessons and where to find out more about each of them.
3 Successful Modern-Day Value Investors to Emulate
- Howard Marks
- Mohnish Pabrai
- Seth Klarman
"There’s a big difference between probability and outcome. Probable things fail to happen—and improbable things happen—all the time. That’s one of the most important things you can know about investment risk."
— Howard Marks
1. Howard Marks
Howard Marks manages Oaktree Capital, a $100 billion-plus fund specializing in distressed debt. Decades of distilled wisdom from managing for Citicorp, where he rose from equity analyst during the "Nifty Fifty" era for stocks, all the way to Director of Research (and Vice President).
By the mid-80s, Marks had moved on to TCW Group, where he met his future partner, Bruce Karsh. The two formed the first distressed debt fund, getting out way in front of the curve on unsavory (to the market as a whole) things like junk bonds and private equity. As of mid-2021, the S&P 500 returned around 300% (with dividends reinvested), while Oaktree returned a staggering 2300%.
Warren Buffett has stated that when he sees a memo from Marks in his mail, it's the first thing he opens and reads, and he always learns something. Such a ringing endorsement by one of the most respected investors of all time speaks volumes, but Marks's memos themselves say even more. Read every single one of them here on Oatktree's page. Start at 1990.
"Heads I win, tails I don't lose too much."
— Mohnish Pabrai
2. Mohnish Pabrai
Mohnish Pabrai's investing perspective is unique. After working in tech, he started his own company in 1991 with $30,000 he had saved up and $70,000 in credit card debt. A decade later, he sold this company for $20 million, with which he started Pabrai Investment Funds.
Today, the fund has mushroomed to over $600 million, and money consistently invested with Pabrai returned nearly 20 times the original investment over about 20 years (the S&P doubled over the same time frame, including the lost decade).
Pabrai has evolved a great deal in more recent years, starting out as a proudly proclaimed clone of Buffett and Munger's style of investing, especially focused on the cigar butt style (buying insanely cheap businesses that have that one last puff in them but have been discarded by everyone else).
Now, however, he looks for hundred-baggers—stocks that return 100 times your original investment—and so the approach is a great deal more qualitative. Pabrai has dozens of items on a checklist he uses when identifying such companies, and he only swings at pitches when he feels like they're really, really easy to hit. He's willing to wait a long time between investments if needed.
Read Pabrai's The Dhandho Investor: The Low-Risk Value Method to High Returns to understand his thought process, or just listen to him speaking on YouTube (there are hours of great content including interviews and lectures).
"Value investing is at its core the marriage of a contrarian streak and a calculator."
— Seth Klarman
3. Seth Klarman
Seth Klarman has been interested in investing for most of his life, owning his first stock at age 10 (Johnson and Johnson, for the record). He also participated in several entrepreneurial ventures.
After graduating magna cum laude from Cornell, and then while extracting knowledge and a degree from Harvard Business School, Klarman cut his institutional investing teeth at Mutual Shares Fund, learning under the tutelage of Max Heine and Michael Price. In 1982, he opened The Baupost Fund, which has averaged a phenomenal 19% since inception, consistently obliterating the S&P 500's 12.5% (with dividends reinvested). Over 29 years, the S&P would return about $300,000. That same $10,000 invested with Baupost? Over $1.5 million.
Klarman is perhaps the most renowned and revered value investor among other value investors, maybe even giving Buffett a run for his money in terms of adoration and emulation. His method is pure Benjamin Graham in many ways: ultra-patient, heavily insisting on a margin of safety, and (when appropriate) incredibly contrarian.
If you're lucky enough to find a copy of Klarman's only book, Margin of Safety, you might want to snag it quickly: it retails for around $1,000 a copy on Amazon. You can also read Seth's early letters to Baupost shareholders.
Mohnish Pabrai insists that copying is usually a more effective strategy for an investor to employ than trying to innovate yourself. By studying great value investors, you can emulate the styles that work best for you and discard the rest.
Howard Marks's core mantr—to take care of the downside and let the upside take care of itself—has been a tremendous key in Seth Klarman's investing success over the last three decades. All three of these value investing titans have lessons for the rest of us, and since all three willingly give fundamental investing advice out to those who will listen, simply tuning in and hearing what they have to say can be one of the most important and valuable weapons in an investor's arsenal.
Listen, learn, and emulate as you see fit, and you can take advantage of the low-hanging fruit that is distilled investment wisdom and maximize your long-term returns.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2021 Andrew Smith