Book Review: Brandes on Value
Brandes on Value: The Independent Investor. 2014. Charles H. Brandes, CFA.
Brandes on Value: The Independent Investor presents excellent long-term insights into the field of value investing by well-known value investor Charles H. Brandes, CFA, a colleague of Benjamin Graham and founder of Brandes Investment Partners. In 1971, Brandes, an investment dealer fresh out of school (he studied math and economics), met Graham, the father of value investing, in La Jolla, California, where Graham lived after retiring from teaching at Columbia University. The two met frequently back then; Graham loved teaching, and Brandes reread Graham’s two most famous books (Security Analysis and The Intelligent Investor) and became a fervent disciple of value investing. Brandes on Value, a follow-up to Brandes’s 2004 book, Value Investing Today, provides a broad and timely update to what the author calls a “myriad of tumultuous” topics that have evolved since his earlier book. Value investing, however, remains the same: buy cheap with a margin of safety, avoid the herd, and think long term. Brandes presents all this and much more in a very clear and enjoyable fashion. (In the interest of full disclosure, I have been a member of the Brandes Institute, which develops investment ideas and research, since 2003.)
Brandes on Value has four main parts:
- “Why Do Value Investing?” discusses 50 years of market history, shows what value investing has produced, and details the main benefits of value investing — higher returns, lower volatility, and lower trading costs.
- “Where One Finds Value” covers behavioral biases (a major generator of value stocks), Graham’s concepts of intrinsic value and the margin of safety, and the fact that value is everywhere, including small-cap stocks; the European, Australasian, and Far Eastern (EAFE) markets; and emerging markets.
- “Value Investing in an Ever-Changing Market” discusses value versus glamour, shorting, 130/30 funds, target-date funds, active versus passive indexing, smart beta, fixed income, and hard assets (gold, commodities, art, and real estate).
- “Value in Portfolio Management” covers the long-term superior performance of equities despite periods of negative returns, explains the various types of portfolio risk, and includes a very well-done discussion of value investing in bonds, an often-overlooked topic that Graham wrote about extensively in Security Analysis.
A number of major themes run through the book, of which I would like to mention three: behavioral biases, the need for independent judgment, and the long-term view.
Behavioral biases in real-world investing continually present opportunities in value stocks. People unconsciously make investment decisions on the basis of psychological biases. Studies in behavioral finance have identified the main flaws as faulty intuition, extrapolation, overoptimism, anchoring, and hindsight. As Brandes says, “Value investing . . . based on decisions on fundamentals and looking for cheap and often out-of-favor stocks has proven to be successful over 80 years . . . certainly before behavioral finance became a topic of formal study.”
The discussion of these biases includes a compelling section on efficient market theory (EMT), respectfully outlining the weak, semi-strong, and strong forms and noting that it still has many followers. In Brandes’s view, however, the 1987 crash, in which the S&P 500 Index fell by 30% in six days, and the rise (in the late 1990s) and fall (in the early 2000s) of the dot-com bubble clearly reflect a shortcoming in EMT. The author’s examination of the market moves in 1987 and the late 1990s also includes numerous case studies of individual stocks. Brandes cites the late value-investing academic Robert Haugen, who studied EMT throughout the 1990s and concluded that “the market is highly inefficient and overreactive.” Haugen is in good company with Charles Munger, Warren Buffett, Robert Shiller, and other luminaries. Brandes’s overall summary is that “knowledge and experience are essential . . . but . . . insight into investor behavior and how it influences the value of companies is empowering.”
That value investors must remain independent and be willing to swim against the tide of popular opinion is a need that Brandes recognized in his early days with Graham and has experienced throughout his 40 years with Brandes Investment Partners. He recounts the criticism of investor clients and past examples of the difficulty of going against the trend. These examples include staying out of Japan in the 1980s before it began its lost decade; the beginning of the dot-com bubble in the late 1990s, when value lagged badly; and the 2008–09 financial crisis, when value stocks bore the brunt of the early sell-off. Following each of these events, value stocks performed quite well, but the lesson is clear that value investors must be able to withstand criticism of their independent judgment and stick with their beliefs. After all, what they believe is ultimately in their clients’ interests.
Finally, a long-term view is essential in value investing. Brandes supports this point with numerous charts, including a 40-year (1974–2014) comparison of rolling three-year MSCI EAFE Index performance versus the S&P 500. It shows that the S&P 500 outperformed the MSCI EAFE from about 1990 to the early 2000s. Over the whole 40 years, however, there were several long periods when the MSCI EAFE outperformed the S&P 500. Brandes’s takeaway is that value investors still need to follow both markets and continually search for value in them. Another chart shows that the S&P 500 far outperformed gold, commodities, global equities, and US bonds over 1977–2013, despite substantially underperforming each of these asset classes during some intervals. Brandes depicts the superior performance of value over glamour from 1968 to 2012, originally shown in a famous paper by Josef Lakonishok, Andrei Shleifer, and Robert W. Vishny. This evidence once more demonstrates that value clearly outperforms over the long term, despite interim periods of underperformance.
Brandes on Value is written in a very lucid, informative, and readable fashion, with topics appropriately grouped under the four parts enumerated earlier. With his clear, concise prose, the author is especially adept at explaining complex topics. His text is helpfully augmented with extensive references and data. All in all, Brandes on Value is a highly worthwhile contribution to the literature on value investing.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.