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Would Benjamin Graham have lost a bundle in the current market?

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By John Beveridge - 
Benjamin Graham The Intelligent Investor book economist

如果在去年使用Benjamin Graham的传统 75/25 股票和债券投资方法,就不会成立。

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It is interesting to consider that the widely acknowledged father of value investing – Benjamin Graham – would have had an absolutely terrible investing year.

Mr Graham – who was the inspiration for the world’s greatest investor, Warren Buffett, was perhaps best known for his 75:25 rule.

As he wrote in his seminal 1949 book The Intelligent Investor: “We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds.”

“There is an implication here that the standard division should be an equal one, or 50:50, between the two major investment mediums,” he added.

It has always been a matter of debate as to how those varying proportions between bonds and stocks would be worked out in practice, but the entire premise of Mr Graham’s investment strategy was that bonds and shares would move in different directions, safeguarding his investment strategy.

The inverse relationship between bonds and shares has been smashed

Admittedly it has been an unusual time in investment markets but Mr Graham’s strategy would have been an absolute stinker.

Assuming Mr Graham, with his strong value approach, would have been deterred by ultra-high share valuations on the US market last year, it is likely he would have been up towards the top of his bond exposure when share markets finally turned down.

That tactical asset allocation would have left him relieved that he missed out on the worst effect of the 20%-plus downturn in the S&P 500.

Graham would have been slammed by bonds

The kicker though, is that Mr Graham would have been slaughtered on the bond market, which turned down an amazing 5.93% as measured by the Bloomberg US aggregate bond index between January and March this year – the worst quarter for more than 40 years.

Bonds are still tanking too, falling by double digit percentages as interest rates keep rising, handing out a nasty lesson to those who thought that bonds were always ideal for preserving capital and safety.

The traditional idea that stocks and bonds move in an inverse relationship certainly hasn’t held up in the last year and is unlikely to for some time.

Graham would have adjusted for current trends

Now it is always dangerous to assume too much about somebody like Benjamin Graham – I’m sure he would have adjusted to the current situation in many ways – perhaps withdrawing from both the bond and share markets and expertly picking the turning points in both as a time to reinvest.

He was a great analyst of shares and it is likely he would have still done well in selecting good companies in a variety of circumstances, although his capital preservation focus would not have done well during the simultaneous fall in share and bond markets.

Buffett has changed value investing for the better

Indeed, watching how Warren Buffett has reacted to the current strange investment situation has shown how much value investment has developed over time so that it hardly resembles Mr Graham’s 75:25 rule.

For a start, Mr Buffett invests in a range of vehicles that Mr Graham didn’t – the most striking being futures contracts.

Futures are dangerous but Buffett uses them

While Mr Buffett has consistently warned about the dangers of futures – back in 2002 he called derivatives “financial weapons of mass destruction’’ – he has also been an enthusiastic user of conservatively using futures contracts as a way to reduce risk and take maximum advantage of mispricing situations.

In admitting that Berkshire Hathaway had 251 derivatives contracts in 2008 with a face value above $37 billion, Mr Buffett told his shareholders “I believe each contract we own was mispriced at inception, sometimes dramatically so.’’

He went on to say the “float” on the derivative contracts was $8.1 billion – a float that he equated to Berkshire’s impressive returns on insurance pools.

“If we break even on an underlying transaction, we will have enjoyed the use of free money for a long time,” Mr Buffett explained.

Since then, Berkshire Hathaway’s derivatives dealing has grown – as has its wholesale acquisition of large businesses which are brought into the company fold and provided with capital to suit their potential returns.

Buffett moves with the times

There are many other ways that Mr Buffett has progressed value investing on the “bond” side of the equation, using instruments like corporate bonds that combine the potential to convert into shares but also have large interest payments.

Like Mr Graham, Mr Buffett likes to have a significant cash pile but he is less focused on government bonds and more on using that cash to seize opportunities when they arise during extreme market conditions.

This year was a great time for employing that technique, with Mr Buffett grabbing big slabs of energy companies at low prices after the market swooned just before oil prices went rocketing upwards.

Mr Buffett’s skill is in seizing opportunities when assets are mispriced works on both sides of the equation – for various forms of cash or fixed interest style investments and for shares or futures contracts.

It is a lot less simple than Mr Graham’s 75:25 rule but in the past year it has been proven to be far superior.