Wednesday, July 1, 2009

Answers from Joel Greenblatt

In a previous post ("My Questions for Joel Greenblatt"), I wrote,

GuruFocus announced it will be hosting a question and answer session with Joel Greenblatt and solicited questions from readers. Below are the questions I submitted for Greenblatt. For others' questions, click the link above.

Why did you set the minimum market cap to $50 million on your new Magic Formula screener, when users used to be able to enter a market cap as low as $1 million on your original screener? Did you find that the Magic Formula does not work as well for stocks with market caps below $50 million? If so, would you mind reimbursing me for the money I've lost buying Magic Formula stocks with market caps below $50 million1?

In your book The Little Book that Beats the Market, you alluded to the dramatic under-performance of a certain investor's2 strategies in the few years after he published a book on those strategies. Do you think it's a coincidence that the few years following the publishing of your book have been difficult times for adherents of the Magic Formula as well? Is it possible that, by the time someone decides to write a book on an investment strategy, that strategy is typically due for a period of under-performance?

1A joke, Prof. Greenblatt. I find that having a sense of humor helps in handling market losses.

2You didn't mention this investor by name, but I believe you were alluding to James O'Shaughnessy.

Yesterday, GuruFocus posted the answers to the questions to which Greenblatt deigned to respond. Greenblatt ignored my first question above, about why he added a minimum market cap to his Magic Formula screener, and offered this semi-answer to my second question,

A new updated study [of the Magic Formula's recent returns] should be published at soon.

Another GuruFocus poster asked an interesting question, about the merits of using a long-only equity strategy such as the Magic Formula if we are in a secular bear market. Here was Greenblatt's response:

A new updated study should be posted on in the near future and the results appear to be quite good relative to a flattish market over the last 10 years or so. Also, since the market has not performed well over the last decade or so, that may turn out to be a good time to invest, not a bad time.

It's worth remembering, when reading that answer, that Greenblatt started working on Wall Street "at the end of 1981" (as he noted in response to another question. So he became a professional investor right before the beginning of an unprecedented 18-year secular bull market. It's not surprising, given that experience, that Greenblatt would recommend a long-only equity strategy to the masses, but I wonder whether that makes sense at this point, since, as Vitaliy Katsenelson has pointed out, secular bear markets (or range-bound markets, as he calls them) tend to last about as long as the secular bull markets that preceded them. That means we could be in for another decade or so of more of the same. Perhaps a more opportunistic approach would be better.


DaveinHackensack said...

Incidentally, I left a similar comment on GuruFocus, in which I included the paragraph below:

"Another question came to mind when reading this: why is Greenblatt interested in writing investment books his kids will understand? Kids born into families with the money Greenblatt has generally don't waste their time speculating in stocks: their financial affairs are managed by family offices of the sort run by firms such as Guggenheim Partners. Maybe Greenblatt is just affecting a sort of "aw shucks" regular guy shtick here (similar to Buffett's public persona), but kids born into middle class families have more important things to worry about than stock picking: they need to figure out how to make a living when they grow up."

Albert said...

I read his responses. Perhaps his comment re a book his kids would understand is to point out that he is hoping that his books will enlighten the masses and demystify the process of investing and understanding the market. I have two different advanced degrees (but neither in finance/economics) but still felt a little overwhelmed and nervous when I first decided to take control of all of our family investment decisions a few years back. I have many very smart (and well paid) friends who still feel like the stock market is a black box. A book such as the one JG mentions would only serve to empower people I think.

Just my $0.02.

DaveinHackensack said...

I think Greenblatt means well. He seems to be an egalitarian who has a passion for education (he started a charter school, for example). But I also think that advocating an unhedged, long-only equity strategy during a secular bear market is problematic. Greenblatt himself isn't exposed like that: he has revenues from businesses he owns; as he mentioned in his answers, some of his funds use long-short strategies, etc. The Magic Formula makes sense, but perhaps it should be complemented by other strategies that provide some bear market protection.

You could argue, I suppose, that adding such complementary strategies would make things more complicated for the masses. That, IMO, is less an argument against including such strategies than it is an argument against a DIY approach. The challenge, though, is that most of the financial planners or investment advisers the average retail investor has access to know little beyond the standard dogma of modern portfolio theory, efficient frontiers, diversification, etc.