And Then What? Insights from the Benjamin Graham Conference

And Then What? Insights from the Benjamin Graham Conference

by Will Ortel, CFA Institute

And then what?

Keep asking that question and you’ll stay out of trouble, says Charlie Munger, a man we would all do well to emulate.

Nearly 125 years after the birth of Ben Graham, the investing profession’s organizing genius, that same question loomed large over a group of practitioners gathered at the New York Society of Security Analysts (NYSSA) for the Annual Benjamin Graham Conference, during which they considered the future of an activity with a rich past — and an uncertain future.

Leon Cooperman, CFA, formerly of Goldman Sachs and presently of Omega Advisors, set a less-than-promising tone for the day. Noting the rise of passive investing and the reasonably high probability that automation will transform numerous professional fields, investing among them, he suggested that younger attendees would perhaps be best served by seeking employment in some other industry.

After all, the business of fund management is to deploy capital in search of unusual returns, and the consensus in our world is diminished opportunity.

There are only so many sources of return.

For investors in common equities, they are traditionally considered an expansion in earnings, an expansion of the multiple at which those earnings are valued, or some form of financial engineering that accelerates the delivery of earnings — present or future — to equity holders.

The former two — the organic sorts of growth — are not thought to be forthcoming in the current environment.

In aggregate, the largest US companies are not growing sales. I can hardly remember a major economic development in recent history that did not cause the International Monetary Fund (IMF) to revise its growth outlook downward. Indeed, the IMF pointed to Brexit this time, but it also revised estimates downwards every quarter this year.

It’s still good sense to look for reasons why an index might rally further, but be prepared for a profound feeling of ennui. In the absence of organic growth, investors have shifted their appetites towards predictable cash-flow streams. General Mills’ rich valuation is an illuminating case in point. The company trades for more than 20 times its projected earnings in the next year. An optimist might see this as a harbinger of innovative breakfast experiences to come. An analyst is more likely to consider it part of a broader flight to perceived safety.

A bond-like stock might just be tailor-made for this purportedly low-return environment, but those disposed to that school of thought would do well to do more than just read macroeconomic commentary about the implications of such a phenomenon — there is no shortage of analysis. Think: What happens after a low-return environment?

It goes away.

Indeed, when my colleague Roger Urwin gave thoughtful and pragmatic guidance on “Asset Allocation in a Low-Return Environment” almost 10 years ago, it would have been difficult for most observers to imagine the rapid shift in sentiment that followed. JP Morgan bought Bear Stearns for $2 a share just 16 months later, and a low-return environment gave way to a generational buying opportunity.

I am not forecasting a crisis, nor did any of the panelists. But many believe that risks loom within indices apparently priced for perfection.

One signal indication of that came when conference moderator Michael Oliver Weinberg, CFA, turned the conversation to the utility sector. He asked “Does anyone feel the growing adoption of solar technology is not an existential threat to these companies?”

Silence.

And this is not a small matter. Investors in utility companies are in many cases making their allocations under the theory that not much will change, or at least not to an extent to affect demand for the product their assets are developing: electricity.

This is a bad assumption. We are likely to see material shifts in both the energy demand profile and the way power is generated going forward. It is doubtful utilities will respond in a universally nimble fashion.

Indices don’t cure idiosyncrasy.

This should be obvious to those who remember that last year Facebook, Apple, Netflix, and Google (FANG) may have contributed more to the return of the S&P 500 index than the other 496 companies combined. But panelist Steven Bregman, CFA, of Horizon Kinetics, took it a step further. He sees more than just “no values in the sector funds,” but idiosyncratic risk as well.

It would be foolish to forget that some sector funds are really quite concentrated in just a few companies. The utility sector exchange-traded fund (ETF) has more than 25% of its portfolio in its top three holdings, as of this writing. The energy sector ETF has almost 34% in its top two.

That doesn’t mean there is a famine of opportunity. Far from it.

Against this dour macro commentary, Miguel Fidalgo of Triarii Capital was quick to point out that the world doesn’t move in macro lockstep: “We’re invested in Greece . . . it’s not the top of the business cycle over there.” This was perhaps the understatement of the day, but it made the useful point that we are poorly served by letting dour headlines become the full story. Indeed, there are certain to be individual cash-flow streams that grow no matter what happens. That’s why staying positive and driven is so critical to our long-term success as investors.

But though individual names and income streams may grow, the way we invest has gotten a little bit weird. The Economist recently profiled the amazing rise of Vanguard, which in general has been a massive boon to investors, including myself. Few question Vanguard’s motives, but it may be time to wonder about the long-term implications of the investment philosophy it has long championed.

Bregman noted an “ETF Vortex” that, in his view, is distorting the clearing prices of almost all large assets around the world. An index can create a self-reinforcing notion of value, so this makes some sense.

It should also create opportunity.

Whatever distortion ETFs, indices, the US Federal Reserve, or anything else is creating in asset prices, it’s worth remembering that markets work in an altogether better fashion today than they did in Ben Graham’s time. The notion that we could use accounting information to make a decision about which companies to invest in was once controversial. The job title “investment analyst” has not existed for that long.

In a sense, it is remarkable progress just that we have a forum for these conversations. But we shouldn’t take too much comfort from that. A forum is only as good as the curiosity that it feeds, and so a big part of me is glad that so many thoughtful practitioners joined us to ask — in one way or another — and then what?

I hope you’ll join us next time.

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