smartwomansecurities
October 18, 2006
Value Investing:
“Doing what comes [un]naturally”
Andrew Weiss
President and Chief Investment Officer
Weiss Asset Management
This presentation is made only for informational and academic purpose. This presentation neither constitutes an offer to sell nor a solicitation to invest in any of the funds
managed by Andrew Weiss (collectively, the “Funds”). Solicitations to invest in the Funds are made only by means of a confidential offering memorandum and in
accordance with applicable securities laws. This presentation has been prepared from original sources and data and information contained in the presentation is believed to
be reliable. No representations are made as to its accuracy or completeness. An investment in the Funds involves a high degree of risk and is suitable only for sophisticated
investors. There is no assurance that either Fund continues to invest or will at any time in the future invest in any of the securities referenced herein.
1
Past performance is not indicative of future results and there is no guarantee that the Funds will meet their investment objectives or be profitable.
Rules for Daily Life vs. Logic Driven Analysis
Rules for Daily
Life
•Avoid empty restaurants.
•Network externalities:
Some products are more
valuable if your friends
also own them.
VS
Logic Driven
Analysis
•In stock market, popularity
is fully reflected in price.
•“Buying what your friends
own” doesn’t increase risk
adjusted returns. Familiar
names may be riskier.
2
Rules for Daily Life vs. Logic Driven Analysis
Rules for Daily
Living
•Gut instinct useful for
many decisions; e.g.
detecting aggressive
intentions.
•Evidence: Damage to
prefrontal cortex hurts
decision process.
VS
Logic Driven
Analysis
•Market price already
reflects gut instincts of
others.
•I use my gut instinct to
find places to search for
contrarian opportunities
3
Rules for Daily Life vs. Logic Driven Analysis
Rules for Daily
Living
•“Believe in yourself.”
•Optimists are popular.
•Project self confidence.
VS
Logic Driven
Analysis
•Know your limits.
•Doubt yourself.
•When you buy or sell the
other side may know
something you don’t know.
“In the fight between you and the world, back the world.”
– Kafka
4
Rules for Daily Life vs. Logic Driven Analysis
Rules for Daily
Living
•Join consensus.
•Ridicule idiosyncratic
views.
•Pass litmus tests for
“soundness”.
•Choose stocks your
friends like.
VS
Logic Driven
Analysis
•Choose portfolio to
maximize risk adjusted
returns.
•Don’t get embarrassed by
owning junk.
•A poor-performing
company can be a
profitable investment.
5
Rules for Daily Life vs. Logic Driven Analysis
Rules for Daily
Living
•Relationships matter for
success.
•Group loyalty – shared
beliefs (tribalism).
•Emotional and
psychological supports.
VS
Logic Driven
Analysis
•Markets are anonymous.
•Paying more for “We listen
to you!” is an expensive
form of psychotherapy.
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Aren’t you on the team?!
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Value Investing Is Psychologically Difficult
Uncertainty
Aversion
•Avoid political, legal, or
other “unquantifiable
risks”.
•Buy solid companies
VS
Risk
Aversion
•For any security there is a
price which will increase
your risk adjusted returns.
•Idiosyncratic risk is good.
8
Value Investing Is Psychologically Difficult
Slogans
VS
Logic Driven
Analysis
• Use “stop-loss” orders.
•“Bygones are bygones”.
• “Take profits”.
•“Ignore what you paid”.
• “Paper” gains or loses are
not real.
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Value Investing Is Irreligious
Slogans
•The “market” punishes
greed.
•“Bulls make money, bears
make money, pigs lose
money”.
VS
Logic
•The market is not a Pagan
god.
•The market doesn’t care
about what you paid.
10
Value Investing Is Psychologically Difficult
Predisposition
•“Sell decision is harder
than buy decision”.
VS
Logic Driven
Analysis
•Buy and sell decisions are
almost identical.
•Every investment is a
contest with cash.
11
Disciplined Analysis is Emotionally Stressful
Predispositions
•Need explanations for
events that affect us.
•Anthropomorphize the
market: “The Market is
consolidating gains!”
•“Don’t fight the tape!”
VS
Market
Discipline
•Don’t try to predict short
term price movements.
•Accept your ignorance.
•Don’t watch your stocks.
12
“All human errors are impatience, a premature
breaking off of methodical procedure…” -Kafka
Evolutionary
Success
•“Don’t just stand there,
do something”.
•Fight or flight.
VS
Investment
Success
•Wait. Think.
•“Don’t just do something,
stand there”.
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“If, after the first twenty minutes, you don't know who
the sucker at the table is, it's you.” ~Author Unknown
Evolutionary
Success
•Alpha types succeed.
•“Lead, follow or get out
of the way”
VS
Rational
Skepticism
•You can’t “motivate”
markets.
•Watch out for winner’s
curse.
•Why is the other side
selling to you?
•What do you know that
others don’t?
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Our Evolutionary Legacy
Learning
Patterns
•The physical world
follows predictable cycles:
seasons, tides, animal
migrations, monsoons.
•Evolutionary success can
depend on learning these
patterns.
VS
Inventing
Patterns
•Our brains see patterns in
random data – coin flips.
•Even if price patterns
were real, they will change
as people learn them and
make trades based on
historic patterns.
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Our Evolutionary Legacy
Pre-literate
Analysis
VS
•Imitate successful actions.
•Learn from personal
experience, stories, legends.
There is no other available
data.
Quantitative
Analysis
•Use data.
•Databases contain
thousands of experiences
that are accurately recalled,
and can be analyzed.
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Our Evolutionary Legacy
Our Evolutionary
Legacy
VS
•Expertise is known within
small tribe.
•Past success is a good
predictor of future
success: Follow the person
who found the last water
hole.
Rational
Skepticism
•Chance can create
“experts”.
•Past 1-3 year returns have
poor predictive power.
•Anyone who could
predict short run price
movements would trade
options – make billions
17
Our Evolutionary Legacy
Pre-numeracy
rules of thumb
•Separate mental accounts to
ease computation costs.
•Prune decision tree.
•Ignore some possibilities.
•Remaining possibilities are
overweighted.
VS
Quantitative
Analysis
•Mathematics can perform
complicated computations.
•Gauge portfolio risk, not
individual risks.
•Gains from diversification.
•Compute conditional
probabilities.
•Avoid assigning zero
probability to unlikely events.
18
Russia: high risk, long term investment
• In 1996, entire Russian stock market was valued
at less than Home Depot.
• Funds had fixed expiration dates, some owned
domestic shares of Gasprom which were priced
at fraction of ADRs.
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Kazakhstan: moderate risk,
long term investment
• Price of Kazakhstan Fd. crashed after Russia crisis.
• Bought KIF for less than cash.
• Cancelled shareholder obligation to put up more money
–returned cash; cost basis near zero.
• Sold assets cut expenses and returned more cash.
• Remaining asset: $13 million of cash
• Possible lawsuit against previous investment manager
• We own 68% of the shares.
20
Vietnam: moderate risk,
long term investment
• Bought Beta Vietnam Fund for less than cash
and less than 30% of our valuation of the net
worth.
• Gained majority control, replaced management,
distributed cash, sold assets.
21
China B Shares: moderate risk,
short/medium term investment.
• China B shares were selling for less than ½ price
of identical A shares.
• Senior advisor said domestic investors should be
allowed to buy the B shares.
• China B share investment trust redeemable
monthly, traded at discount to B shares, bought
and redeemed repeatedly.
• B and A share prices converged.
22
Taiwan Fund: low/moderate risk,
short term investment
• Redeemable index tracker fund, one week of market
risk.
• Shares priced at midpoint between today's and
yesterdays close.
• Brokers were given limited allocations.
• Established relationships, bought $14 million at 2+%
discount with one week of market risk – could hedge
with future contract.
23
Thailand: moderate risk,
medium term investment
• Thai domestic funds with fixed wind-up dates,
large annualized excess returns, illiquid.
• Placed orders every day for roughly 30 funds at
discounts generating 20+% excess returns.
24
Turkey: short/long arbitrage
• Bought Turkey Growth Fund in Luxembourg at
17% discount, shorted Turkey Fund in U.S. at
75% premium.
• Closed position when spread narrowed to 35%.
25
Macro-Economics and Fundamentals
• 1993-4 Philippines trading at 16 times earnings
with no electricity and barges with gas
generators sitting in Manila harbor – first stock
tip when I spoke to this class.
• 1989-90 German re-unification, German stock
market boomed, Germany fund traded at 50+%
premium –short.
26
Macro-Economics and Fundamentals
• 1993-4 Philippines trading at 16 times earnings
with no electricity and barges with gas
generators sitting in Manila harbor – first stock
tip when I spoke to this class.
• 1989-90 German re-unification, German stock
market boomed, Germany fund traded at 50+%
premium –short.
27
The Other Side
Why Others Don’t Do What We
Do
28
Why other investors don’t
buy what we buy
Weiss’s Decision
Investor Response
Buy Kazakhstan
Investment Fund
Turned off two large
potential institutional
investors:
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Value Investing Can Hurt
Weiss Decision Response By Peers
Recommended
Mexican
Industrials in
1982
Financial
Consequence
Ridiculed by Hd of Price of Mexico
Corp. Finance for Fund went up more
major investment
than 1000%.
bank
30
Value Investing Can Hurt
Weiss Decision
Result
Stay out of U.S. market Underperformed
during bubble
Nasdaq in late 1990s.
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Hard to Attract Investors
• Institutional Investors Rely on “Signals”
Investors fear unfamiliar names
–
–
–
–
Kazakhstan Investment Fund
Beta Vietnam Fund
Ukraine Fund
ICP-SEMF Pakistan
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Value Investing is “Hard Work”
•
•
•
•
•
Uncertainty about amount and entitlement to undistributed
revenue: prospectus may conflict with Articles of Assoc.
Option value: effectively zero preference shares have
written a long dated call to the ordinary shares
Value voting rights The board can reallocate expenses,
change dividends, repay bank debt, change portfolio
allocation.
Positive spillovers from real value of splits being realized.
Difficult to compute optimal hedge.
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34
Choose Your Battles
• Invest in under researched markets – avoid
competing against Goldman Sachs.
• Gain sufficient expertise and develop contacts
with market participants so that competitors
suffer seriously from winner’s curse.
35
Shareholder Activism
• Do Well by Doing Good.
• Replace Boards of Directors
• Speak at conferences, write articles, give
interviews.
• Litigate when necessary – establishes reputation
for fighting for investors.
• Negotiate early liquidations
36
Results from Analytical Approach
• No losing years for diversified funds since
inception in 1992.
• Alpha approximately 20%
• Gross Return since reorganization in 2002:
52% in 2003, 42% in 2004. Market risk was
fully hedged.
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Q&A
38
39
Popular Market
Stocks Returns
Excess
Profits
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