The investing world lost a titan of value investing this week with the untimely* passing of Charlie Munger.
Untimely has an asterisk because there probably won't be another like him.
Munger is known for many quotes, but the most famous is probably that it is better to buy great companies such as Costco at fair prices than fair companies at great prices. The point is that you won't be able to find many people willing to sell at extremely low prices. Unless you buy thousands of such companies (which is what quantitative investment is about) you'll make more money buying a great company at a fair price from lots of people.
The philosophy of buying great companies at fair prices first gained wide recognition from a CNBC interview in May 2016. This philosophy actually runs counter to the value approach that an ETF such as IVE employs. IVE and its competitor RPV use three measures of value: Book/Price, Earnings/Price and Revenue/Price. The common denominator here (both mathematically and figuratively) is price. If the price is sufficiently low, then the company is likely to show up on your value screen regardless of how good it is.
So how did these value ETFs do after that 2016 interview?
It's a stretch to say that the interview caused value to start doing poorly, as the main lagging is due to IVE not holding TSLA, GOOG or AAPL.
Likewise, the underperformance of RPV relative to IVE is more likely attributable to it not holding MSFT, META or AMZN than the difference in weighting scheme. (RPV weights based on value where IVE is market cap weighted.)
All the companies mentioned however are great companies, so in a sense value ETFs have lagged because they are too focused on cheapness.
The question then is how might we identify the great companies that still offer some value?
One idea is to look at the intersection of holdings of a value ETF and ETFs that are trying to find great companies, such as growth (IVW) or quality (SPHQ).
If we look at the historical performance of the current holdings of these ETFs and their intersections, we find that individually adding a value component is unhelpful, but combine all three and we've found some stocks that have outperformed.
To be clear, this analysis is highly imperfect as we're just looking at the current holdings, which by virtue of being in the indices at present must have done something good.
We are applying the same process for each however, so the fact that adding value to the intersection of growth and quality didn't detract from returns is still notable. This does of course mean that those companies on the whole probably don't look that cheap at present.
Another idea is to look at the holdings of Berkshire and see which of them are in the value ETF at present. If we apply the same process as above, we find that the current holdings of BRK that are in IVE look cheap.
In particular there are 5 stocks that are more than 5% below their level from a year ago: PARA, BAC, KHC, KR and KO.
Of these, we would only consider BAC, KHC and KO where Berkshire has a position greater than 1% of their total.
We already have a position in BAC in the absolute return portfolio so that's one great company that we got at a fair price.
Both KHC and KO have cheapened as a result of the trend for weight loss drugs this year, but KHC was already in a big down trend so they don't look like a great company any more.
So we've KO'd every company in IVE except KO.
KO has one other distinction, which is that it is the only company that Berkshire holds that is also in all of SPHQ, IVE, and IVW.
That looks like another great company at a fair price.
1. On the screen: ECH
ECH is the MSCI Chile ETF. Its biggest holding is SQM, which is in the lithium mining and also the fertilizer business. Chile is also known for producing copper. This means that ECH is a way to trade increased demand for construction materials from China.
The weakness in Chinese markets this year means that ECH has lagged its Latin American counterparts in Mexico and Brazil.
This should mean that Chile is much less crowded, so there is potential for the current uptrend in ECH to extend significantly further as China tries its best to help the housing sector,
ECH is in overbought territory at present, so we will look for some profit taking from short term traders to provide a more favourable entry point.
2. Portfolio positions
As discussed on Beat The Market, we're sticking with our current positions for now.
So far our hedged BAC position has performed better than we hoped, with BAC rallying strongly, but the market having only drifted slightly higher since we initiated the position two weeks ago.
SPXU is not a long term position due to the convexity costs of holding inverse ETFs. As such, we intend to exit the hedge if and when we see a correction in the market.
The current portfolio weights are as follows:
In our equity portfolio we sell 8.2% XLI and buy 7% XLB. Materials and industrials are highly correlated, but materials are more levered to China, and in particular, to what we expect to be significant demand for construction materials. Materials was the best performing sector last week, but probably remains significantly underowned given the weakness in Chinese stocks this year. We think it will continue to rally.
In the Global Asset Allocation Portfolio, we are underweight US and international equities and underweight US bonds.
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Munger was also often quoted as saying that he just wanted to know where he would die so that he would never go there. I doubt that he thought 99.9 is better than 100.
BRK-B didn't have any significant response to the news. I'm wondering if the same will be true with Buffett. I'm also wondering whether Berkshire will still be useful as a source of capital for banks in the next financial crisis. That is, does an investment from Berkshire carry the same weight if it isn't Buffett making the decision?
Buffett is known for drinking 5 cans of Coke a day. I don't think that anybody emulates his diet though, so this doesn't mean anything for their sales.