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Secrets for the Small Investor
Transcription of interview with Joel Greenblatt on October 3, 2011:
Douglas Goldstein, CFP®, Financial Planner & Investment Advisor
Joel Greenblatt is the founder and managing partner of Gotham Capital, based out of New
York. He is an adjunct professor at Columbia University Business School. He started as
a pure value investor with the influence of Warren Buffet and other great investors. He
is a New York Times best-selling author with his newest book being The Big Secret for the
Small Investor, which talks about a new route towards long-term investment success.
Douglas Goldstein, financial planner & investment advisor, interviewed Greenblatt on Arutz Sheva
Radio.
Joel Greenblatt: The world has become much more institutionalized over the last 30-40
years, which means that institutions have to perform each year or they lose their customers.
Most investment managers respond by looking at the short-term, meaning trying to find
things that will do well in the next year or two. This leaves a whole bunch of opportunities
for people who are willing to take a longer-term horizon with their investments and look past
the next few years when they look at things to buy.
If there is a company that might not be doing as well in the next year or two as it did
last year or there is some uncertainty involved, there is a big opportunity to look at those
on a value basis and buy them, as long as you’re willing to be patient. But most professional
managers just can’t be patient because their clients aren’t.
Douglas Goldstein: This is what happened after 2007, when the market hit such a low that
they had a negative 10-year track record S&P-500 and people said, “I was a long investor.
I waited 10 years and I’m in a hole.” What would be the response to that?
Joel Greenblatt: I’m actually a value investor, and in the simplest form what a value investor
would try to do is figure out something’s worth and pay a lot less. That’s what I
call “value investing.” This is the strategy that I recommend in the book, which is continually
rebouncing, making sure your portfolio is stuck with companies that earn a lot of money,
but you don’t have to pay a lot for those earnings, yet at the same time, they’re
earning high returns on capital, which I talked about in my previous book also. It just means
they are very good at putting the money to work in the business whenever they invest
in their business.
You have these two things - one was Ben Graham, who said to buy something cheap, and the other
was Warren Buffet who was a student of Ben Graham and said it’s nice to buy cheap but
if I can buy good business cheap, that’s even better. These two concepts should be
combined into good and cheap companies, and if you follow that, you would have made quite
a bit of money. You would have made about 10% or 12% a year during the period when the
market was not up at all. That’s just constantly rebouncing towards those cheapest companies.
The fact that the market can go up over 10 years doesn’t mean that it didn’t bounce
around at all a lot during that time, and the markets are quite emotional over the short
term. There are plenty of opportunities, if you have a disciplined approach, to take advantage
of that.
Douglas Goldstein: This disciplined approach is as opposed to something which is more opportunistic.
Do you hold by buying things other than stocks?
Joel Greenblatt: My expertise is in the area of stocks, and what we designed is actually
some smarter indexes. Most people are familiar with the S&P-500 or the Russell 1000. These
are just standard indexes of a large amount of stocks, but they’re weighted by their
market capitalization, meaning that the larger the company is, the larger the weight the
stock has in its index. With the S&P-500, for instance, which is the index that most
people benchmark their returns against, the top 20 names out of those 500 names in that
index account for about 33 percent of it. It’s not even that widely diversified and
it’s also actually not a great way to invest because what I believe and I think the Ben
Grahams and Warren Buffets of the world would also agree with this. Just by observing and
reading the paper and watching what goes on, whether you’re talking an internet bubble
or whatever it is, is that markets over the short term can be very emotional.
If that’s true, some stocks at times are overpriced and some stocks are underpriced.
What the market cap-weighted index like the S&P-500 does is that any time a stock is overpriced,
it will buy too much of it because it’s measuring how much it should buy by market
price, and the higher it is the more it buys. If the stock is overpriced, you automatically
buy too much of it in a market cap-weighted index. If the stock is a bargain, its price
is low and the index automatically buys too little of it. In that way, it cost you about
2% a year.
Douglas Goldstein: You’ve spoken about rebouncing and owning a lot of stocks. Do you think that
this applies to investors of all ages? For example,e someone who’s owned stocks now
is retiring. Would it still be appropriate for him?
Joel Greenblatt: What I was talking about in the new book is a smarter type of index
approach. There are all kinds of indexes, and the one I talked about already was market
cap-weighted. Basically in the book, I discussed how we came up with what we called the value-weighted
index, which basically just puts more value in the cheaper stocks and we do that for you.
We actually created some mutual funds that are effectively index-like in the fact that
they have 800 to 1000 stocks and they are very diversified. We are just trying to take
advantage of this phenomenon, but like anything else, every strategy that differs from a standard
index will have times where it outperforms and underperforms. The key to sticking with
something that’s underperforming is to understand what you’re doing.
I’ve spent a lot of time writing books and trying to explain the philosophy behind what
we’re doing and the logic behind it so that when things don’t go well, people don’t
give up on that strategy because they think it makes sense over the long term even though
over the short term it may not.
I will give you a couple of statistics that I think are pretty interesting, and I wrote
some of this up on the book. One of them is that if you look at the top managers over
the last 10 years, the top mutual fund managers, and you look at the top quartile, meaning
the best 25% over the last 10 years, out of the 25% that ended up with the best record
over a 10-year period, 97% of those guys spent at least three years in the bottom half performance,
79% of the top performers spent at least three years in the bottom quartile, the bottom 25%
of performance and approximately half of those top managers after 10 years, 47% of them spent
at least three years in the bottom 10%. So you know what would happen to most of those
managers who ended up with the best long-term record. People would run from them because
they had long periods of underperformance and I think that’s the problem for individuals.
The other problem for individuals is that they don’t know what logic goes into managers’
picks and all they see is the performance data. They can look back over the last three,
five or 10 years of the performance of a mutual fund manager and that’s how they usually
pick their mutual funds. Unfortunately, there is no correlation between how a manager did
in the last three, five or 10 years and how they’re going to do in the next three, five
and 10 years, so people are kind of lost.
Douglas Goldstein: Aren’t they’re going to end up looking at the ratios like the beta,
which looks at the volatility compared to the rest of the market, or look at the alpha
which shows the value that the manager added?
Joel Greenblatt: Alpha is just another fancy name for who outperformed. Looking at that
number doesn’t help you predict who will outperform. It just looks at
the past.
If you are really evaluating people, you would have to evaluate their process and then you
would determine how much was luck and how much was skill, but it’s almost impossible
to do that with managers. Seventy percent underperformed the market averages over long
periods of time, and what that means is that’s why most advisors recommend index funds - because
70% of active managers underperformed and there are no reliable ways to find those other
30%. It’s almost as hard as commercially picking stocks yourself. It’s just as difficult
a challenge to pick managers that will be future winners.
Douglas Goldstein: You’re very involved in philanthropy. Specifically, you’ve focused
on setting up schools to help underprivileged kids to succeed. Could you just give us a
little thought about where you see that going?
Joel Greenblatt: I know Israel has their challenges in public education, and the U.S. does also.
It’s a very uneven system where some schools are good and some schools aren’t. Unfortunately,
in the poor neighborhoods, they are generally the ones that get the worst schools, less
funding and everything else. Wealthy parents can move and go into a good school district
the way it works in the U.S. or pay for a private school. Poor parents don’t have
that option and to give them an option, there’s a movement to set up charter schools. These
are schools that are set up under different administrations and rules than the regular
public schools.
Traditionally, they’re not unionized and they are not subject to a lot of the different
constraints of regular public schools. The hope there is to create models that work better
for these underprivileged kids. My day job is as a capitalist and I believe strongly
in that system, but it will only work if everyone has a fair chance. I thought that starting
education at young ages was really the way to equalize the system. It’s been a fun
project and so far so good.
Douglas Goldstein: Could you tell how we could follow the work that you’re doing?
Joel Greenblatt: The best way to do it is go take a look at www.valueweightedindex.com
where I explain the value index that we set up. We started over the last 20 years and
have beaten the S&P-500 by 7% a year during that time. You could read both of my books.
I’ve written three, but the two that I think would be most helpful to people is The Little
Book That Beats The Market, which I wrote about five or six years ago and updated last
year, and The Big Secret For The Small Investor.
Douglas Goldstein, CFP®, is the director of Profile Investment Services and the host
of the Goldstein on Gelt radio show (Monday nights at 7:00 PM on www.israelnationalradio.com.
He is a licensed financial professional both in the U.S. and Israel. Securities offered
through Portfolio Resources Group, Inc., Member FINRA, SIPC, MSRB, NFA, SIFMA. Accounts carried
by National Financial Services LLC. Member NYSE/SIPC, a Fidelity Investments company.
His book Building Wealth in Israel is available in bookstores, on the web, or can be ordered
at: www.profile-financial.com (02) 624-2788 or (03) 524-0942.
Disclaimer: This document is a transcription and/or an educational article. While it is
believed to be current and accurate, divergence from the original is to be expected. The original
podcast can be heard at https://sites.google.com/site/goldsteinradioshows/. All information on this website is purely
information and should not be used as the sole basis for making financial decisions.
The opinions rendered herein are those of the guests, and not necessarily those of Douglas
Goldstein, Profile Investment Services, Ltd., or Israel National News. Readers should consult
with a professional financial advisor before making any financial decisions. Please see
the complete disclaimer at https://sites.google.com/site/goldsteinradioshows/.