We were on our way to be 100% passive investors. That is still the long-term idea. But along the way we researched value funds and we decided allocate some funds to them. Although today our index funds are behaving much better, we do not regret having the following funds in our portfolio:
Why aren’t we just invested in index funds?
Our portfolio also has index funds and thanks to them we have OK returns as of today in this first year. The fear I have is the overweight that these indexes have of companies with valuations that I think are too high. I speak of Amazon, Netflix and company. They are companies where a bright future is already priced in the stock. If the future is less than perfect there can be a very big drop. In exchange for this risk, they have generated incredible returns for investors. It is partly thanks to them that our indexes are have returned so much since the beginning of the year.
Problems may come from rising interest rates, trade wars, armed conflicts, or whatever triggers the panic of investors. And when the problems come I will feel more protected in the active funds, although I know that they will also take a hit. At the moment, most value funds, although composed of fewer companies, are having less volatility than the indexes.
I know this is trying to time the market. Which I know we should not do because nobody is able to predict waht will happen. If the index funds fell by 50% and the value funds remained flat, we would probably move everything to the indexes. However, except for very large changes, we will probably continue with this portfolio until the end of the year.
From all non-index funds… Why value?
In my opinion, if any passive investor were forced to choose an actively managed fund, he would choose a value fund. The mentality for both is very similar: patience, long term, holding steady through downturns, etc. Other funds offer to knock it out of the park or to be smarter than others. The value managers highlight that they are not fortune-tellers and that the returns need time.
As we show on our target portfolio, our biggest bet is on a value fund: Cobas Internacional. It has been losing more than 5% since its start. It does not seem a great success in the short term but we believe that it will be in the long term.
Why are we investing so much on Cobas?
I think it can be said that Cobas is the investment management company that generates the most debate and controversy in Spain. To give a silly example, the manager is called Francisco García-Paramés but he prefers to be called “Paco”, even in interviews. However, when people talk about “Paco” they are criticized by others because “it seems that they know him but they don’t”. So we usually use the initials: FGP. What other fund in the world generates controversy by how you call the manager? Anyway…
The fact is that FGP is one of the best managers in Spain due to his track record. Some say that the investment managing company azValor has the same track record because they worked with him in the investment managing company of Bestinver, when they generated the returns that made him famous. However, when FGP started Cobas, he hired several of AzValor’s analysts who had been with him at Bestinver. This is a pretty strong signal for me, I don’t think the analysts will jump ship just like that for a pay raise. In my mind there must be some conviction as well.
FGP couldn’t manage funds for 2 years after leaving Bestinver, due to a non-compete clause in his contract. When he came back, he published a book and started Cobas Asset Management. Everyone thought he would go to AzValor but he didn’t. Much debate has also been generated about why and whether there was a conflict between managers.
The fact that he has set up the new company is a key point. He is risking his reputation and potentially his professional future with these funds.
Alignment of interests
We bought Cobas International with an average price below 98. ITs initial price was 100. That is to say, if in the next year it achieves an annualized return of 10% we will not only get 10%. We will get more than 12%. And having bought it later than when it started we will have that 12% in less than a year so the annualized return will be even higher. In other words, our returns as investors will be higher than those of the fund.
The minimum recommended time to be invested in value funds is 5 years.
If within 4 years (5 for the fund, since we entered a year after its start) FGP only manages to keep the fund flat (price 100), we will get around 2%. However, he would lose his reputation in that situation.
Unfortunately, this is not the case in other funds that we have. If a fund returned 40% last year and we get in this year, we are not aligned in the mid-term. If it ends up flat this and the following, the manager can still get out and proudly say that he got more than 10% in the last 3 years. It is more or less the case of our contributions to Japan Deep Value, but we bought it because we like the strategy and we think good way to diversify. Although in the target portfolio we have assigned only 5%. For me this alignment of interests is important. I would not like to be in the situation where the manager succeeds despite not having given me any return. But there are a few times that you have the opportunity to have this alignment. Even fewer with a well-known manager who in a way bets all his prestige (besides his own money, as do almost all other managers).
Time puts everybody in their place. Sooner or later all managers have to perform and can’t live on past returns forever. Hence, when your time horizon is 20 years, everybody is betting their reputation on it. What matters is how good the manager is and not so much the specific moment of the fund. But the fact that one of the most reputable managers in Spain is risking everything on this and his funds are cheap, made us think. It is possible that by the end of the year we will continue contributing and that Cobas will have more weight in our portfolio.
Disclaimer: Obviously I am not encouraging anyone to invest in Cobas or any of these funds. I have no hidden interest. Everyone should make their own investment decisions.