Value Investing and the Art of Doing Nothing

"It is awfully hard work doing nothing."
(Oscar Wilde)

When I am asked what is the most difficult thing when applying a value strategy one thing right away comes into my mind. Doing nothing!

The human brain is just not wired for doing nothing. It asks for activity, constant stimulus and instant gratification. Humans are pattern seekers. Something is going up they expect it going up further and vica vers. There is a strong tendency to overweight recent events and extrapolate them into the future, e.g. the recency bias. They fail to incorporate the concept of reversion to the mean in their strategy.  (Maboussin)

Doing nothing requires a heck of discipline.


As far as I am aware Benjamin Graham has hardly touched on  the subject of emotional preconditions a successful value investor should have, mainly persistence and patience. Most people don't have it. They like action and instant reward. But deep value investing doesn't work like this. In most deep value situations it takes time till the underlying value does materialize, often years.

"The comfort and encouragement to the intelligent investor are to be found in practical experience. In the long run, securities tend to sell close to a price level not disproportionate to their indicated value.This statement is indefinite as to time; in some cases the day of vindication has actually been deferred for many years." (Buffett; Supermoney)

The most famous remark on that subject comes from Warren Buffet, when he said  "The stock market is a no-called strike game. You don't have to swing at everything -- you can wait for your pitch. The problem when you're a money manager is that your fans keep yelling, 'Swing, your bum!'" 

Doing nothing does not sit well within the professional investment community. In most fields activity and results are correlated. But not so in the investment business. Many studies have shown that activity diminishes longterm returns.(Maboussin)

In the case of institutional money management another fact, apart from the lack of individual emotional preconditions, comes into play. Namely career risk. The money manager might have the discipline a value investor needs. But the institutional framework of constant benchmarking its performance against the index does not allow for the time needed for the investment to play out. If he hangs on a lagging investment for too long, he risks its career.

Regarding the importance of patience in value investing McElvaine, a canadian value investor who used to work for Peter Cundill, notes: " A lot of people who come into the business want to do something. They like the activity, I think it comes a little bit from—our business today is like Xbox on steroids, right? You can get the game in front of you, you see the lights flashing, you can hit a button and buy and hit another button and sell.There’s lots of adrenalin; it’s exciting. So for me, I kind of operate at a completely different spectrum. I make Homer Simpson look active because there’s not that much excitement happening in my office. I can go to the bathroom and not worry that I missed making a million dollars because of a portfolio decision. So my sister had this poster up that said, “Sometimes I sit and think, and sometimes I just sit.” That kind of summarizes a day at the office for me."

 Mohnish Pabrai is also aware of the importance of patience when it comes to value investing. "You don't make money when you buy a stock, you don't make money when you sell a stock. You make money by waiting. The single best advantage an value investor has is not IQ. It's patience and waiting. (...) All investment manager's misersy stems from its inability to sit in a room alone and do nothing."  He goes on to note: "Actually the investment business is set up the wrong way. The correct way to set it up is to have gentleman of leisure who go about their leisurely tasks and when the world is severely fearful is when the put their leisurely tasks aside and go to work. That would be the ideal way to set up the investment business"

Especially in Japan I find being patient with your holding extremely difficult. The main reason is that so so many bargain issues are available, which come in different flavours. Every now and than I find myself contemplating switching a lagging holding to one that shows more price dynamics. Mc Elvaine is conscious about this issue too, but warns: " (...)The important thing is not to get distracted by greener fields, because every day you come in there’ll be something over there that looks like it might be more interesting. It’s kind of like with a girlfriend or a boyfriend, and for sure if you’re on a diet you can look at the menu, but you’d better not go and start sampling unless you’ve decided you’re no longer on the diet. Same thing with investing, for me at least. It’s fine to go and look at all these other stocks to see because they look interesting. To actually make the purchase and sale decision, you have to be really careful because the only thing we control in this business is when you buy and when you sell. That’s the only one thing I can do. I can’t make the stock go up or down."

Andre Kostolany, who was a well known german investor, used to answer when asked how to get wealthy: "Buy Stocks . Than you take a sleeping pill, wake up 10 years later and realise that you have become rich." Although being a huge fan of Kostolany's witty remarks regarding the stock market and investing in generell, I consider this particular statement one of his weakest and maybe most dangerours one. Because the art in doing nothing, is when to know and sense to get active and agitate swiftly and decisively. "Certainly, maybe investing in general is really boredom with moments of pure panic in between. A lot of time there’s nothing to do, and then all of a sudden there’ll be those moments where there’s something to do.You need to make sure that in the boredom times, you are getting yourself ready to act when you need to. But you don’t need to do everything every minute." (Mc Elvaine)

Furthermore, I am always amazed where the main contribution to overall performance comes in my portfolio at a certain point of times. Almost always it ends up to be the stock which you least have on the radar that given year. The one which has been dirt cheap, but which hasn't gone anywhere for two years +. The one where it seems to be more exciting watching paint dry than following the price chart. McElvaine seems to be with me on that one. He notes:"The interesting thing too is quite often the ideas you’re most focused on will languish and the one that you’ve kept in the portfolio because you think it’s cheap but you’re not expecting anything out of it this year…suddenly something happens. So, yeah, it’s kind of funny that way. You start a year and you never know exactly where your gains are going to come from, at least in my case."

A leading investment manager of a billion-dollar fund had delivered himself of a statement that money management was a full-time job, not only week by week and day by day; “Securities must be studied on a minute-by-minute program.” “Wow!”Warren wrote.“This sort of stuff makes me feel guilty when I go out for a Pepsi.” (Adam Smith; Supermoney)




Source:

Warren Buffett, “Chairman’s Letter to Shareholders,” Berkshire Hathaway Annual Report, 1996.

Maboussin on Strategy; The coffee can approach; Why doing less can leave you with more (March 2011)

Adam Smith; Supermoney; Wiley

Stockmarket Superstars; Secrets of Canada's Top Stock Pickers; Tim McElvaine

http://www.youtube.com/watch?v=oaL2v1nVokw (Mohnish Pabrai Interview)