Value investor Christopher Davis just released his 2018 Fall Review for the Clipper Fund. The Clipper Fund returned 6.1% in the first seven months of 2018, and over the last three years has slightly outperformed the S&P 500 Index with a cumulative return of 43% versus 42% for the index.
Davis says active managers can still find opportunities in today’s market due to:
- Time Arbitrage
- Geographic Inefficiency
- Accounting Distortions
- Understanding Intangible Assets
- Sector Inefficiencies
- Index Distortions
- Headline Risk
Of particular interest to value investors is the last topic – headline risk investments, which Davis describes as follows:
Finally, mispricings can be created because the structure and incentives of many money management firms make them reluctant to invest in companies that their clients might consider controversial. After all, when clients read in the newspaper about a company plagued by scandal, the last thing they want to see when they open their investment report is their expert money manager has purchased the scandal-plagued company they just read about.
As a result, many investment managers either will not look at companies that are under a cloud or, if they had previously purchased them, will sell the entire position at discounted prices. The problem with this approach is their decision has nothing to do with the economics or prospects of the company in question, but instead is focused on short-term client perception.
As a result, shares in durable companies tainted by scandal can often represent buying opportunities that we refer to as headline risk investments.
In evaluating these investments, our research focuses not on the past but on the future, asking whether the problems that have come to light can be fixed and if so whether the decline in share price represents a buying opportunity. Buying shares when a company is in the headlines for unfavorable reasons is never easy and in no way reflects a minimizing of a company’s past mistakes.
But organizations like people can learn from their mistakes and often emerge stronger. We believe our willingness to look beyond the headlines can lead to fantastic opportunities. Although there are no certainties, our analysis indicates that both Facebook and Wells Fargo will emerge from their recent scandals as better companies and that recent selling has been overdone. As a result, we established a position in Facebook this year and added to our position in Wells Fargo when the headlines were unfavorable.
With more than $150 million of our own money invested in Clipper Fund, our primary concern is making smart investment decisions rather than reacting to short-term investor perceptions.
Because our firm’s incentives drive an investment culture rather than a sales culture, our willingness to invest in controversial companies should come as no surprise. While investing in companies with headline risk can unsettle clients in the short term, such a discipline reflects our alignment of interest with our shareholders over the long term. This alignment is an uncommon advantage given that 88% of all funds are overseen by managers who have less than $1 million invested alongside their clients.
You can read the entire Clipper Fund 2018 Fall Review here.
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