On Value Traps; Exercise for Brain Health!

From: aditya rana
Date: Sat, Apr 9, 2016 at 1:33 PM
Subject: On Value Traps; Exercise for Brain Health!


One of the most challenging situations for a value investor is being caught in a “value trap” – where a cheap investment suffers a permanent loss of capital. What strategies and precautions should investors adopt to minimise the risk of being ensnared in a “value trap” ? Rob Arnott, head of Research Affiliates, provides a helpful perspective on this issue. To summarise:

A “value trap” can either imply that an asset that looks cheap has enough bad news to possibly justify the price or the investment looks cheap on the way to zero.

-Ben Graham made a distinction between a drop in price and a permanent impairment of capital – as mean reversion cannot work if he price of a security goes to zero. However, ascribing a “value trap” to an asset which has suffered a large price decline when the underlying fundamentals remain unimpaired, one can make a dangerous error. A “value trap” is a situation where the asset seems cheap but is permanently impaired.

-Bargains mainly exist in the presence of fear – by inflicting pain with sharp price drops – but there are always numerous reasons to avoid buying bargains which deter investors from taking advantage of price drops.

-How often do individual company stocks present a permanent loss of capital – say a 90% drop in the price in three years or less and no recovery over the next three years? At any given time only 5% of US stocks are “value traps” – i.e. they are rare events for individual stocks and almost nonexistent for broad asset classes which represent a broadly diversified array of companies and therefore cannot all go to zero.

-Markets try to seek fair value and are therefore mean reverting. Analysing historical data since 1975 for each major asset class, and defining a significant decline as a two standard deviation move below its long term average, these extreme events have happened only 2% of the time.

-Comparing the percentage of asset classes and individual stocks (see chart below) which suffered such extreme declines and recovering fully over the subsequent five years, it is clear that asset classes outperformed individuals stocks by far – more than half the time assets classes made up their losses within 3 years and 85% did so over five years. However, only 10% of individuals stocks recovered with three years and one-third did so over five years.

-It is painful to experience a price loss – particularly as value has underperformed growth since2013 (and off-and-on since 2007). However, early signs of value outperformance are emerging – particularly for US small cap value stocks and EM equity.

-A few fundamental truths about investing can help investors to continue pursuing a value-oriented, disciplined and contrarian strategy: 1) value traps are rare events, particularly for asset classes; 2) mean reversion can reward patient, long-term investors; and, 3) history shows that markets eventually trend towards fair value. Investing on a contrarian basis can ultimately provide superior returns to investors.

-An interesting analysis which supports a well diversified, value based approach to investing despite trying market conditions – as the legendary value investor Jeremy Grantham of GMO has noted time and time again – patience is the key advantage which an individual investor has over the professionals (but unfortunately is squandered too easily as people get caught up with the herd mentality).

-The other important aspect to value/contrarian investing is having the discipline and courage to spreading the investments over time (i.e. dollar cost averaging ) thereby allowing one to add to positions which have suffered sharp price drops. A recent example of this would be Brazil, a country which has been out of favour for several years and has suffered sharp drops in the equity index as well as the currency (see chart below).

-Over the last three years, the annual fall in the dollar denominated country ETF EWZ has been -25%,-16%, -51%, driven by both a fall in the local currency (-14%, -10%, -34%) and the stock market. An investor employing a dollar cost averaging strategy over the last three years (starting from January, 2013 and deploying one fourth of his total allocation to Brazil on an annual basis) would show a paper loss of 43% at the beginning of 2015 versus a paper loss of 67% for an investor who had invested his total allocation at the outset (or was reluctant to add more on declines). And following the 33% rally in Brazil this year, the current loss for the dollar averaging investor would be almost halved to -24% versus -44% for the alternative. More complicated dollar averaging strategies can also be employed utilising pre-specified thresholds based on market movements rather than a fixed time of the year to further optimise returns.

-Of course Brazil could suffer another sharp fall for a myriad of reasons (i.e. politics/commodities) but having a disciplined strategy of adding exposure under that situation (in the context of a well diversified global portfolio with limits on individual country and asset class allocations) is very likely to yield dividends over time.

Exercise and Brain Health:

Came across an interesting study on how exercise has a positive impact on brain health:

New York Times, GRETCHEN REYNOLDS APRIL 7, 2016http://content.iospress.com/articles/journal-of-alzheimers-disease/jad160057-More people are living longer these days, but the good news comes shadowed by the possible increase in cases of age-related mental decline. By some estimates, the global incidence of dementia will more than triple in the next 35 years. That grim prospect is what makes a study published in March in The Journal of Alzheimer’s Disease so encouraging: It turns out that regular walking, cycling, swimming, dancing and even gardening may substantially reduce the risk of Alzheimer’s.

-Exercise has long been linked to better mental capacity in older people. Little research, however, has tracked individuals over years, while also including actual brain scans. So for the new study, researchers at the University of California, Los Angeles, and other institutions analyzed data produced by the Cardiovascular Health Study, begun in 1989, which has evaluated almost 6,000 older men and women. The subjects complete medical and cognitive tests, fill out questionnaires about their lives and physical activities and receive M.R.I. scans of their brains. Looking at 10 years of data from nearly 900 participants who were at least 65 upon entering the study, the researchers first determined who was cognitively impaired, based on their cognitive assessments. Next they estimated the number of calories burned through weekly exercise, based on the participants’ questionnaires.

-The scans showed that the top quartile of active individuals proved to have substantially more gray matter, compared with their peers, in those parts of the brain related to memory and higher-­level thinking. More gray matter, which consists mostly of neurons, is generally equated with greater brain health. At the same time, those whose physical activity increased over a five-year period — though these cases were few — showed notable increases in gray-matter volume in those same parts of their brains. And, perhaps most meaningful, people who had more gray matter correlated with physical activity also had 50 percent less risk five years later of having experienced memory decline or of having developed Alzheimer’s.

-“For the purposes of brain health, it looks like it’s a very good idea to stay as physically active as possible,” says Cyrus Raji, a senior radiology resident at U.C.L.A., who led the study. He points out that “physical activity” is an elastic term in this study: It includes walking, jogging and moderate cycling as well as gardening, ballroom dancing and other calorie-burning recreational pursuits. Dr. Raji said he hopes that further research might show whether this caloric expenditure is remodeling the brain, perhaps by reducing inflammation or vascular diseases.

-The ideal amount and type of activity for staving off memory loss is unknown, he says, although even the most avid exercisers in this group were generally cycling or dancing only a few times a week. Still, the takeaway is that physical activity might change aging’s arc. “If we want to live a long time but also keep our memories, our basic selves, intact, keep moving,” Dr. Raji says.

Here’s to staying active throughout the day to keep a healthy mind.




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