Swedroe: Bias Can Override Knowledge

December 09, 2016

The introduction to the new book I co-authored with Andrew Berkin, “Your Complete Guide to Factor-Based Investing,” begins: “If a poll was taken asking investors to name the greatest investor of all time, it is safe to say that the vast majority would likely respond, ‘Warren Buffett.’

Thus, we could say that a major goal of investors the world over is to find Buffett’s ‘secret sauce.’ If we could identify it, we could invest like him—assuming we also had his ability to ignore the noise of the market and avoid the panicked selling that causes so many investors to incur the higher risk of stocks while ending up with lower, bond-like returns. This book is in part about the academic community’s search for that secret sauce—specifically the characteristics of stocks and other securities that both explain performance and provide premiums (above market returns). Such characteristics can also be called factors, which are simply properties or a set of properties common across a broad set of securities. Thus, a factor is a quantitative way of expressing a qualitative theme.”

Indeed, quantitative approaches allow investors to express qualitative themes in a systematic way that avoids the all-too-human behavioral errors to which investors are prone. Wes Gray and Tobias Carlisle’s book, “Quantitative Value,” is all about finding the aforementioned secret sauce and implementing it in a systematic way.

It’s an exceptionally well-written and voluminously researched book that should be a must-read for anyone interested in value investing, whether you believe the source of the value premium is risk-based or behavioral-based. In addition to presenting a wealth of academic research on value investing, the authors offer insights from legendary value investors such as Warren Buffett, Seth Klarman and Joel Greenblatt (creator of Magic Formula Investing).

More Thought Doesn’t Always Mean More Returns

In the opening chapter, Gray and Carlisle present Buffett’s thinking on the issue of value investing: “Most institutional investors in the early 1970s … regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value—and even thought, itself—were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest—whether it bridge, chess or stock selection than to have opponents who have been taught that thinking is a waste of energy.)”


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