Financial crisis has yielded more Ben Graham style “bargain issues”

CIO Insights 1Q2010

As has always been made clear, in our investment program we don’t adhere to preset artificial boundaries in terms of the number of equities owned. Instead, the degree of diversification is a function of how many names we are able to find that (1) present an attractive discount to intrinsic value and (2) uniquely contribute to the Fund’s aggregate asset composition. As a general rule, during times of market buoyancy we tend to hold fewer stocks because some holdings probably will have reached fair value and hence been disposed of, while at the same time it will be more challenging to find compelling new investment opportunities. Along the same lines of reasoning, in depressed markets our universe usually expands as the existing holdings in all likelihood will stay inexpensive and thus remain in the portfolio while it will also be a more fruitful environment to find additional mispriced investments. 

The latter is exactly what happened during the last 2½ years. Up until the onset of the financial crisis, it had been our experience that a normal upper level in the number of portfolio holdings would be about 70. Since then, the exceptional dislocations taking place in the global financial markets have led to the expansion of our investment pool to around 90. What is particularly interesting to point out – using Ben Graham’s terminology of potentially undervalued situations in his book The Intelligent Investor – is that most new names finding their way into our portfolio during the crisis can be labelled “bargain issues” as opposed to the “relatively unpopular large corporation.” In other words, in contrast to many other market participants, it has not been our strategy to take advantage of the crisis by buying the large, well-known firms whose prices have been crushed, hoping for an eventual rebound based on their “blue-chip” status. Instead, we took new positions in companies of medium and smaller size that tended to be neglected and otherwise avoided by the market even before the crisis set in. Once these securities’ prices became engulfed by the general market gloom, their implied margin of safety became all the more compelling to us, bringing them down to a level that rendered them highly attractive in price-to-value terms.

Accordingly, most of the new investments can be attributed to pockets of value to which we have had big exposure even prior to the crisis. Representative examples are: capital intensive engineering firms with “lumpy” and thus difficult-to-forecast revenues and order flow; “messy” conglomerates and holding companies trading at big discounts to their sum-of-the parts worth; “old-media” firms with heavily discounted assets owing to the threat of, and shift to, new media; and underappreciated land ownership or similarly neglected asset values hidden on the balance sheet of less well-known companies.

In contrast to the sectoral emphasis, where existing pockets of value were confirmed and reinforced as delineated above, the geographical focus of the additional “bargain issues” became more pronounced, with respect to three countries in particular: first, Japan became an even bigger weight in the Fund, as this country for us is the perfect example where the backdrop of a long-depressed macroeconomic situation offers a slew of grossly neglected investment opportunities. Second, whereas we always struggled pre-crisis to find inexpensive US companies fitting our mold, quite a few fell into our lap during the thick of the market sell-off. And third, Italy newly became a prominent place for us to invest as the market has difficulty appreciating the somewhat complex corporate structures (conglomerates and family-controlled holdings) characterizing many equities listed there.

Sincerely,