Oxstones Investment Club™By Gregory Zuckerman, WSJ,
The hard lessons from Rob Arnott, Jeremy Grantham, Howard Marks and Jeffrey Gundlach
Even the superstars swing and miss. Much of the time, in fact. That is as true in investing as it is in baseball.
Last year, 79% of actively managed U.S.-stock mutual funds failed to top their benchmarks, according to research firm Morningstar Inc., the worst year for relative performance in modern history. At the same time, more individuals gave up trying to beat the market at all, as investors pulled nearly $99 billion from actively managed U.S.-stock funds last year and moved $71 billion into index funds.
Can’t anybody play this game?
We figured it was a good time to ask four acclaimed investors with records of top performance what they learned about markets and investing from some of their hits and—maybe more so—from their misses.
Wealth Management
Rob Arnott: Learned to stick to his expertise.
Rob Arnott
Founder and chairman of Research Affiliates, known for a quantitative investment strategy that has beaten the market over the long term.
HIT: In February 2000, after trailing the market for more than a year as investors bid up tech stocks, Rob Arnott’s research team at First Quadrant LP tweaked its investment model to reduce the emphasis on “value” stocks—those trading at a low price relative to their earnings—and increase exposure to surging tech shares.
About a month later, when he found out about the move, Mr. Arnott ordered the model returned to its original stance, sticking with the firm’s value orientation.
It was in the nick of time. Tech shares soon cratered, value held up well, and the firm scored impressive returns and gained clients.
THE LESSON: “When your strategy goes against you, the natural inclination is to try to figure out what’s wrong with your strategy, but that’s dangerous,” says Mr. Arnott, whose current firm, Research Affiliates, has been buying out-of-favor emerging-markets shares lately. “Don’t fight the most recent battle, over and over again.”
MISS: Mr. Arnott was convinced opportunity was afoot. The Dow Jones Industrial Average fell almost 7% on Oct. 13, 1989, after a leveraged buyout of airline company UAL Corp. collapsed.
Mr. Arnott was sure the “minicrash” was unwarranted, and he headed to First Quadrant’s trading floor, positioning himself next to his traders as they prepared to follow the firm’s models and scoop up shares. “I wanted to make sure we took advantage,” Mr. Arnott recalls. “So I hovered around.”
Big mistake. Mr. Arnott was an unusual presence on the floor. “I got them so nervous that they were waiting for my instructions,” he says. He never gave them any, waiting instead for the perfect entry point.
It never came, and the market began to recover before the firm’s buying began in earnest. Opportunity was lost.
THE LESSON: “Don’t get involved if you don’t have expertise,” Mr. Arnott says. “My expertise is taking advantage of bargains, shunning what’s expensive, not short-term trading.”
Jeremy Grantham: Learned to avoid speculation.
Jeremy Grantham
Chief investment strategist at GMO LLC in Boston, known for warnings about both the late-1990s tech-stock bubble and 2008’s credit bubble.
HIT: When Jeremy Grantham’s firm took a cautious stance on popular but expensive tech stocks in 1999, performance suffered and clients bolted. He and his team stuck to their guns and were rewarded when tech shares crashed and the firm rebounded sharply in the early 2000s.
Too many investing pros are afraid of immediate-term “career risk,” Mr. Grantham says, so they chase hot investment trends instead of aiming for superior long-term returns in cheap, unloved corners of the market.
GMO, the firm Mr. Grantham co-founded, was one of the first to emphasize an asset-class allocation strategy, which many rivals shied away from, likely because large multiasset bets carry more career risk. The market is more likely to misprice asset classes than individual securities, however, so they “offer more opportunity,” he says.
THE LESSON: “There are inefficiencies in moving global assets around, not unlike stocks decades ago,” he says. “The bigger the range of assets you can invest in, the less competition you will have and the better the opportunities.”
MISS: Mr. Grantham became interested in stocks at 16 when a family friend shared an upbeat outlook for his company. Mr. Grantham quickly bought up shares. Within about a year, the company was in an accounting scandal and the shares were worthless.
He didn’t learn. Fourteen years later, Mr. Grantham heard a pitch for American Raceways, a company that was going to introduce Formula One racing in the U.S. “I got hooked,” he says. “We thought we would make money beyond our dreams.”
Mr. Grantham bought 300 shares for himself at $7 and went on vacation to Germany with his wife. When they came home three weeks later, the stock was at $21. He sold everything else he had, borrowed more money and soon owned 900 shares. Months later, American Raceways hit $100. “I figured I had the golden touch.” Were millions of dollars to come?
But the stock began tumbling. It dropped more each day, torturing Mr. Grantham. Americans weren’t ready to embrace Formula One racing after all.
The stock went down so fast that Mr. Grantham worried he wouldn’t be able to pay back his lenders. He managed to exit the position with just enough money to pay his debt.
THE LESSON: “I realized investing wasn’t a game,” says Mr. Grantham. “I swore off speculation for life. I became a cautious, value investor.” (Meanwhile, as the couple’s net worth soared and then plunged, Mr. Grantham’s wife refrained from pointing the finger at him—another “powerful lesson,” this time in the importance of marrying the right person, he says.)
Howard Marks: Learned that quality isn’t a guarantee.
Howard Marks
Co-chairman of Oaktree Capital Management, a debt-focused firm with strong returns, known for a contrarian investment philosophy.
HIT: In 2004, Howard Marks and Oaktree’s co-founder, Bruce Karsh, saw a bubble developing in riskier debt markets. They pared holdings, suffering as debt prices raced higher.
But when subprime mortgages pulled the financial system down, beginning in 2007, the moves looked savvy.
THE LESSON: “The most important single decision an investor has to make is whether to be on offense or defense.” Turning conservative too early is part of the price that investors sometimes need to pay.
MISS: As a young analyst at Citibank in 1968, Mr. Marks was part of an investment team buying “Nifty Fifty” fast-growing stocks. They got burned, and he has never forgotten.
Yes, many of the companies had high-quality managements and global reach. A few, including International Business Machines Corp., Hewlett-Packard Co., Merck & Co. and Coca-Cola Co., would endure for decades.
Despite that, these stocks slid—some as much as 90%—when a bear market hit in the early 1970s. Mr. Marks’s bosses lost their jobs, and he realized that paying too much even for a strong business can cripple returns.
THE LESSON: “I learned buying high-quality assets doesn’t equate to successful investments or safety,” Mr. Marks says.
Jeffrey Gundlach: Learned to leave a comfort zone.
Jeffrey Gundlach
CEO of DoubleLine Capital LP, known for prescient market calls. In June 2007 he warned that the subprime-mortgage market was “a total unmitigated disaster and it’s going to get worse.”
HIT: It was March 2008, and Jeffrey Gundlach was testing his nerve in a crisis.
Even assuming a rash of defaults and other bad news, debt investments priced at 65 cents on the dollar looked attractive. He began buying, though he knew there was a good chance markets would continue to drop.
“If fundamental value is compelling, you should keep buying,” he says. “It’s OK to take short-term losses.”
Mr. Gundlach was right—prices continued to fall for another full year, eventually hitting 45 cents on the dollar. One big client got nervous and withdrew money from his fund. Mr. Gundlach ran out of money and couldn’t buy more, locking in his cost basis.
Beginning in the spring of 2009, the market launched a furious comeback. Mr. Gundlach’s firm eventually made about $20 billion from the bargain hunting.
THE LESSON: If a stock or bond has fallen, it often means expectations are low, as investors focus on troubles, not possible solutions, Mr. Gundlach says. “Identifiable problems aren’t a reason to stay away from an investment, they’re a reason to look,” he says. “The whole trick to investing is identifying when problems are already discounted in prices.”
MISS: From 2000 to 2002, junk bonds tumbled amid accounting scandals at Enron Corp., WorldCom and others.
Mr. Gundlach, at the time a fund manager at TCW Group, ran a fund focused on mortgages, as well as several other broader fixed-income funds. He crunched the numbers and realized a range of investments were suddenly cheap, even in a worst-case scenario. He itched to buy across various asset classes.
“Clients were terrified, reinforcing my [bullish] view,” he says.
Mr. Gundlach bought junk bonds in his broader funds but stuck with mortgages in his big mortgage fund, even though he had the ability to buy other kinds of investments, including junk bonds.
When the junk-bond market launched a powerful comeback he kicked himself for not doing more. “I didn’t think more broadly about diversifying my strategy,” Mr. Gundlach says.
THE LESSON: Most investors miss huge opportunities outside their comfort zones. “I had a very narrow way of thinking about investing.… I vowed not to do that again,” Mr. Gundlach says. “Most Americans tremble about buying outside the U.S.,” for example, so they squander opportunities.
Mr. Zuckerman is a special writer for The Wall Street Journal in New York. Email gregory.zuckerman@wsj.com.
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