《亚洲投资者》访谈

Asian Investor - Michael Mauboussin Interview

Mauboussin sees abundant 'expectation gaps'

Nov 23, 2009

AsianInvestor: With contrarian investing, is the aim always to achieve alpha, or are you happy with beta some of the time?

Michael Mauboussin: We'd call ourselves value investors rather than contrarian where it makes sense. Second, the aim in investing is to constantly seek assets whose value is substantially higher than their price, by comparing asset fundamentals against price expectations. To take the example of horse racing, the horse's odds represent the price expectation, while the horse form, trainer, track record, track conditions and so on represent the fundamentals. You don't make the most money betting on the favourite, but by identifying the mispricing between expectations and the fundamentals -- the 'expectation gap'. Hence, you should never be happy with beta -- that's not getting you any value for your clients. Alpha what it's all about.

Does your approach to value investing work better in some markets than others? If so, which ones?

Value investing tends to have a difficult time in markets that are very momentum-orientated -- it tends to suffer most when markets become value-insensitive, such as in the recent crisis or in the late 1990s. However, value investing is a tried-and-tested approach and should be successful over time. Value investors would see themselves as being providers of liquidity.

So when the market is down and investors are fearful, they will buy, while they will look to sell when stocks are up and everyone else is enthusiastic. In 2009, it's been a much better environment for value investors -- being able to buy relatively inexpensive stocks has led to good returns.

How about with regard to emerging markets or specific asset classes?

I don't have much experience of emerging markets, but you can scan the universe of value investors and see some that have been successful in such markets -- for example, John Templeton of Franklin Templeton. The value-investing mindset applies to all asset classes, but to different degrees. The fixed-income stream tends to be easier to assess, because it involves fixed cashflow streams from companies, while equities are more difficult because you're not sure when and how much cashflow will come. As for commodities, they are classically affected by supply and demand, but in the past couple of years or so speculators have come in and changed the tenor and tone of that market. So now it's more of a momentum market than in the past, when it was largely fundamentals-driven.

For example, late 2003 would have been a good time to participate in energy -- when commodity prices were low and valuations were undemanding. On the other hand, most fundamentals-orientated investors would be hard pressed to find a case for investing in oil at $80 a barrel [its level around mid-November].

Given that pretty much all investment strategies suffered during the recent crisis, how did your approach help you, and indeed where did it hinder you? Can you give me specific examples?

I have a couple of thoughts on this. Reflecting on 2008, as an organisation we've probably mis-characterised the crisis and underestimated it as a result. We felt it was a liquidity crisis and that liberal monetary policy would therefore lead to a solid rebound. But it was actually more of a collateral crisis. When the price of the largest assets in the market -- real estate -- collapsed, that led to margin calls, more asset sales, more margin calls and so on.

Another thing that caught us flat-footed was the government's desire to take over [US mortgage financing agencies] Fannie Mae and Freddie Mac, and save [US investment bank] Bear Stearns and [US insurer] AIG -- and then to let Lehman Brothers fail. It's not that we didn't consider such scenarios at all, we just underestimated their probability.

The point is that you find 'expectation gaps' by looking coming potential outcomes -- and

Asian Investor - Michael Mauboussin Interview

during this crisis, we may not have looked at enough, or properly weighted, potentially adverse outcomes.

As for where we see things going now, if you want to figure out the magnitude of GDP growth, there's research that shows the magnitude of decline and does a good job of explaining the magnitude of [the subsequent] GDP recovery. This approach predicts US GDP growth for 2010 of 8-9%, which is remarkable. The consensus on GDP growth for next year is actually 2.5% -- so there's a yawning gap. We're not advocating growth as robust as 8%, but we would lean towards the notion that it will be better than people think.

A number of economists have shared this type of analysis -- the one I follow particularly is Ed Hyman of [US firm] ISI Research. He has a good sense of history and good perspective.

How and where did you most succeed in exploiting the 'expectation gaps' in the past couple of years?

We found opportunities in the ability to move up the quality spectrum. That is, by investing in companies that have historically been higher-quality, such as in the technology and financial services sectors. You've been able to get good-quality companies at low valuations. And some of those expectation gaps are persisting in those sectors.

But aren't you worried about potentially major issues in the financial sector, such as increased moral hazard, likely tightening of regulations and so on?

The situation now reminds me of the markets after the Enron scandal -- that got a lot of people to sit up and take more notice. So there is a heightened awareness about the importance of conducting business properly, which may have been less evident during the swell in housing activity.

We'll see what happen with the regulations and what form they take. There are a number of challenges. Firstly, we shouldn't fight yesterday's battles. I don't want to be too pessimistic, but I'm not sure how much people have learnt. As Ken Rogoff and Carmen Reinhart show in their book This Time It's Different, such crises have been part of the markets as long as we've had markets. I would be surprised if we don't have another crisis; that's one of the costs of a market system.

With regard to regulation, the innovation got ahead of the plumbing this time. For example, credit-default swaps are useful and shouldn't be removed altogether, but it would be sensible to have greater transparency around them by having them traded on exchanges and cleared. This would provide more transparency and stability to the instruments underlying more complex financial transactions.

But there is a risk of micro-managing some issues, and I think the US administration is mindful of that. It's also important to bear in mind that financial services is now a global industry -- so you need to have similar regulations from country to country, as otherwise financial institutions will go to where the rules are more favourable.

Do you think investors in general have learned from the crisis -- have people truly changed their views on how and where to place their money? Are there more foxes out there now than hedgehogs?

No. The consistent feature about all these crises is human nature -- it's very difficult to change it at all. So I suspect we'll see the same patterns of greed and fear periodically raising their heads; in a different market, a different place with different actors, but with the same story.

Phil Tetlock, a psychologist at University of California at Berkeley, published a book in 2006 suggesting that foxes -- those that know a little about a lot of things -- make better predictions than hedgehogs, who know a lot about just one thing. Hedgehogs will get their moments of fame -- for example, if you were very bearish in the early phases of the crisis, you'll have made a name for yourself. And the same goes if you were bullish in 2009. You may get it right once, but the question is whether you can string together several correct predictions.