An efficient market, as a popular finance textbook said, has no illusions;37 buy the index. Because the wisdom is already in the price, the EMT model thus has no predictive or analytic value. But then neither does the newer discipline of behavioral finance.38 Its focus is on the mistakes of the investors who have been wrong, not the skills of those who are right. The behavioral patterns have been built up from studies of readily quantifiable errors, such as the fact that Royal Dutch and Shell Transport, which until recently owned fixed portions – 60/40 – in one combined enterprise, often trade in their respective markets at prices that diverge sharply from the underlying economic values.39 Lacking the inherently qualitative tools of Graham-and-Dodd investors, their skills lie in hindsight analysis; hence they, too, fall back on indexing.
Neither of these popular academic models –EMT or behavioral finance – would have enabled one to do what the Goldfarb Ten did so successfully in the early days of 2000, that is, selectively pick up the good values in old economy stocks even while staying far, far away from the Fortune 10 and the like.
These concentrated portfolios reflect the oft-repeated tenet amongst value funds that they invest “bottom-up,”40 company by company, with an almost insouciant disregard for macroeconomic trends, and utter disdain for the market predictions of the day. It is often said that everything is difficult to predict – particularly the future. The value investor copes with this amorphous, unquantifiable macroeconomic uncertainty by focusing on what’s close at hand – a company’s products and market position, the quality of its management and their identification with shareholder interests, profit margins and balance sheets – rather than the prospects for global oil prices, war and peace, interest rate and currency fluctuations, and the like.
There is a note of humility – or is it humble arrogance? – as they remind investors of their insistence on staying within a narrow circle of their personal competence,41 a phrase borrowed from Buffett. Bill Miller of Legg Mason Value likes to cite behavioral finance studies in commenting on market follies. And the scorn is palpable when he talks about the average portfolio manager’s mistakes, such as trying to forecast macroeconomic events, trading too much