Sunday, January 10, 2016

Faber, Invest with the House

Meb Faber, a popular blogger and CIO of Cambria Investment Management, got on investors’ radar screens with The Ivy Portfolio. Since that first co-authored book, he has written Shareholder Yield, Global Value, and Global Asset Allocation. His latest book is Invest with the House: Hacking the Top Hedge Funds (The Idea Farm, 2016).

The same general strategy that informs this book is the rationale behind AlphaClone, a company Faber helped cofound in 2008 but in which he is no longer actively involved. That is, piggyback on the stock picks of the best investors.

Any investor can access the SEC’s EDGAR database and, 45 days after the quarter’s end, view the holdings of every institutional fund with assets under management of over $100 million. Yes, this information may be stale; it provides insight into funds that hold stocks for a reasonably long time (mainly value managers), not those with a high turnover rate. Moreover, the 13F filings list only long positions, so the individual investor has no idea whether or how these long positions are being hedged and what “stand-alone” shorts the fund may hold.

Even so, can the individual investor gain an edge by cloning? Faber answers this question by analyzing the 13F quarterly filings of twenty prominent value investors, going back to January 2000. He creates historical stock portfolios, equal weighting the top ten holdings of each manager’s portfolio. And he rebalances quarterly, adding and deleting holdings and calculating performance as of the twentieth day of the month.
The annualized performance of the S&P 500 from 2000 through 2014 was 4.31%, with a volatility of 15.24%, a Sharpe ratio of 0.16, and a maximum drawdown of 50.95%. This is the benchmark against which Faber measures the performance of his cloning strategy.

Although Faber no doubt cherry-picked the twenty funds (plus, in appendices, more funds that don’t have such a long track record) to ensure that his cloning strategy would be successful, the results are impressive. Cloning Berkshire, for instance, using Faber’s methodology, investors would have had an annualized return of 10.53% with a lower drawdown. Cloning David Tepper’s Appaloosa, the return would have been 20.94%, though with more volatility and a higher drawdown.

Faber’s book not only offers investment ideas but is fun to read. Each chapter introduces the reader to the hedge fund manager and his philosophy before crunching numbers.

And lest the individual investor think, for whatever reason—ego probably topping the list, that he doesn’t need to imitate others, here’s a sobering statistic: “Simply picking a stock out of a hat means you have a 64 percent chance of underperforming a basic index fund and a 39 percent chance of losing money!” (p. 13)

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