Joel Greenblatt Explains Why Hedge Funds? Why Now?
In spite of the fact that total hedge fund assets have fallen a little as exits increased, hedge funds are seeing an increase in new investment. According to Joel Greenblatt, “the answer is in the name – hedge”. He thinks that hedge funds have gained in popularity since 2008 when the market was down 40% and people were wondering what to do with their money. Even now, people are looking for safe places to put their money. Interest rates are terrible, so that leaves stocks and hedge funds.
When it comes to hedge funds, Greenblatt recommends investors be wary about the fees. He feels that the high fees in the hedge fund industry do have a tendency to attract great talent but not all hedge fund managers earn those high fees. Instead, Greenblatt encourages investors to focus on the quality of the hedge fund manager, instead of only the fee volume.
Greenblatt also said that the market is cheap. When asked to explain, he cited the fact the trailing numbers show that most stocks are trading at a fraction times their earnings than they have historically. For an example, Greenblatt pointed to the markets in 2008. He explained that those who bought then did very well, one to two years out. The market did go lower but investors who bought soon after the crash still did quite well.
Joel Greenblatt’s Advice to Investors
Greenblatt’s advice is that investors should stop “fighting the last war” – things could always things get cheaper. His advice is simply to “figure out what it’s worth and pay a lot less.” He cautions that this type of investing – value investing – does work but it works over a normal investment period, like 2-3 years. Greenblatt recognizes that most people do not know how to value companies.
For the average investor, Greenblatt recommends equally rated indexes. While these still make mistakes, they do so randomly rather than systematically. Greenblatt explains that indexes like the S&P 500 beat hedge fund managers more than 70% of the time but to follow it solely usually means that investors end up buying too much of a stock when the price is high and too little when the price is low. All in all, he says these inefficiencies can cost as much as 2% a year.
Greenblatt likes the tech industry, specifically Hewlett-Packard (HPQ) and Microsoft (MSFT), because people are focused on tablets and cloud computing and these companies are trading at very low multiples with huge returns on capital. Greenblatt also noted that defense companies and retail companies are down, largely because of overreaction in the market. He thinks they are priced too cheaply. Greenblatt recommends buying a group of companies in a sector, so that investors are hedged a little against which becomes the favorite. Greenblatt is optimistic on the market.