Beating the Market, as a Reachable Goal
By JEFF SOMMER
Robert A. Olstein finds the arguments for index funds personally
insulting. “What do you mean I can’t beat the market?” he says angrily.
A forensic accountant-turned-mutual fund
manager, he doesn’t aim to do as well as everybody else. “That’s
mediocrity,” he says. Mr. Olstein knows that very few investors manage
to beat the market consistently, which is why so many people have poured
so much money into index funds — more than $3 trillion, including traditional mutual funds and exchange-traded funds, according to the Investment Company Institute.
Such funds mirror the market, and that is enough — or so the thinking
goes. Don’t even try to do better than average, because you probably
won’t succeed. That’s the crux of the argument for using these funds to
capture overall market returns, and it’s based on decades of academic
research, including the work of Eugene F. Fama, one of the finance
professors receiving the Nobel in economic science this weekend.
Nobel or not, Mr. Olstein is far from convinced. To the contrary, he
says the rise of index funds is part of a trend toward sloppy investing —
a willingness to follow the herd, to rely on momentum in a rising
market.
“It’s like saying mediocrity is O.K. — that it’s more than O.K., it’s
the best that anyone should hope for,” Mr. Olstein says. “It’s saying a
guy like me can’t beat the market — that he shouldn’t even bother
trying. That’s wrong! It really ticks me off. I can beat the market. I
have beaten the market.”
And, in fact, he has — not every year and certainly not every week or
every quarter, but over the long run, which, in his case, started in
September 1995. That’s when he founded the Olstein Financial Alert fund,
now known as the Olstein All Cap Value
fund. From its inception through November this year, including fees,
his flagship fund returned 10.7 percent, annualized. That’s more than
2.4 percentage points better than the Standard & Poor’s 500-stock
index, and substantially better than comparable small-cap indexes.
It’s also slightly better than the comparable performance of shares of
Berkshire Hathaway — a company headed by another value investor, Warren
E. Buffett. Berkshire returned 10.3 percent, annualized, during that
same period, according to Bloomberg data.
It hasn’t all been smooth sailing for Mr. Olstein. “I’ve made mistakes,” he readily acknowledges.
The biggest one came in the disastrous year of 2008. Nearly all equity
investors took losses then, but his fund fared worse than average,
losing 43.8 percent, compared with 37 percent for the S.&P. 500
index.
In hindsight, he should have anticipated the possibility that the
government would allow Lehman Brothers to fail. He didn’t adequately
prepare for the collapse of the market. When the bottom fell out, he was
caught holding a relatively high concentration of heavily leveraged
financial stocks, which plummeted further than the overall market. He
has instituted controls to forestall that particular error, though he
concedes that other mistakes are quite possible.
“But if your overall approach is right, you can improve the
probabilities of success,” he says, “and I think that’s what we’ve
done.”
His particular approach relies on skills that he says are “practically
extinct.” They were honed as an auditor with the old Arthur Andersen
& Company, and then, in the 1970s, as co-author of The Quality of
Earnings, a financial newsletter that shed light on the murky areas of
corporate accounting.
While he is aware of macroeconomic trends, he takes a bottom-up approach that isn’t very fashionable these days.
“On Wall Street, so many people are basically just momentum investors,
looking for growth and following whatever is trending up,” he says. “The
market is becoming a casino. I don’t play that game. I care about
specific companies and whether they are good buys at their price, and if
they are, we’ll hold on to them.”
Mr. Olstein looks for stocks that are underappreciated, and that are
strong in a metric he has always favored: “free cash flow yield.” (It is
cash, after subtracting capital expenditures and working capital,
divided by market capitalization.) “Cash is king,” he says. “That’s what
you’re paying for when you buy a stock — the ability to generate cash.
But few people even bother with it these days.”
He says he prefers “boring companies” — if their free cash flow excites
him. One such company is John Deere, the agricultural equipment maker.
He estimates that its free cash flow yield is about 7 percent, a very
high level, and that it’s likely to grow to 10 percent over the next
three years. Its recent prices have been depressed by temporary
phenomena like poor weather and low corn prices, which have slowed down
worldwide equipment purchases. Over the long haul, though, with global
population swelling and demand for food increasing, he says, the odds
are good that Deere will rise in price.
He contrasts Deere with Cisco Systems, the Internet hardware company.
Deere has been boring for decades, he says, while Cisco was one of the
most exciting in the stock market in the late 1990s. Back then, he took a
bearish view on Cisco — correctly, as it turned out.
“Too many people were excited about it,” he says. “It was a good
fast-growing company, but there wasn’t enough free cash flow to justify
the price of a share.”
While Deere shares have quadrupled in price since those days, Cisco is
trading at a small fraction of its former price. Now, though, Cisco has
become boring, too, he says, growing at only a modest pace but
generating cash. Mr. Olstein now holds its shares.
He doesn’t buy initial public offerings, and he’s stayed clear of
Twitter. “It might be a good company, but I don’t see the cash flow, not
yet,” he says.
Most armchair investors aren’t able to do his kind of detailed financial
analysis, he says, and he thinks that most professional investors don’t
do it, either. But scores of money managers do, and he advises amateurs
to find them. Turn to a pro for work like this, he says. “I don’t try
to fix my own teeth, or cure myself when I’m sick. I go to a dentist and
I go to a doctor,” he said. “Find somebody good and go to them.”
Mr. Buffett, of course, is one of the good ones. And there are other
veterans with long, proven track records, Mr. Olstein says. Active,
value investing isn’t extinct yet.
But his success, and that of others like him, doesn’t disprove the
academic theories that underlie index funds In a recent conversation,
Mr. Fama, the Nobel laureate, told me that it’s not impossible for
someone to beat the market consistently. It’s just not likely. There’s
no way to know whether an investor like Mr. Olstein has been successful
because he is skillful or just lucky.
“It could be an anomaly,” Mr. Fama said. “Life isn’t long enough to be able to tell for sure.”
Mr. Olstein doesn’t enjoy hearing that. “The professors don’t advise
their students to settle for mediocrity at school or in other aspects of
their lives,” he says. “Why do it in investing?” http://www.nytimes.com/2013/12/08/your-money/beating-the-market-as-a-reachable-goal.html?pagewanted=all
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