Value trap gets crowded

If your financial adviser put you in a mutual fund that had slumped 24 percent for the year, you’d probably have given him a call by now, right?

That seems to be the predicament that adviser David Mendels is in these days when it comes to Longleaf Partner’s Fund. As Charles Stein reported last week, the Longleaf fund is going through a rough patch after beating the market for two decades.

Indeed, Mendels is probably not the only one getting calls. The whole notion of value investing has seen better days, and this is an alarming trend for the old guard on Wall Street. The concept of buying stocks that appear to be undervalued by the market was pioneered almost a century ago by author and professor Benjamin Graham, who lit a torch that’s been carried by the likes of Warren Buffett, Seth Klarman, David Einhorn and many others.

Using indexes of “pure value” and “pure growth” stocks in the S&P 500, the difficulty for value-oriented investors is easy to see this year. The pure-growth stocks have returned more than 1 percent including dividends, outperforming value stocks by 9 percentage points.

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The last we heard from Klarman’s $28.5 billion Baupost Group, it had posted a 1.4 percent loss in the second quarter and was close to flat for the year, before the real volatility started. Einhorn’s Greenlight Capital was down 17 percent in 2015 as of the end of last month. Even Buffett’s Berkshire Hathaway shares are currently down 13 percent year to date.

A common theme to many of these stories is what’s known as the “value trap” – stocks with valuations that look enticingly cheap lure investors, only to fall further. The trap was set this year in – where else? – the energy sector.

Value investors often operate under the mantra of staying true to your thesis and riding out times of hardship like this with confidence that your picks will eventually deliver. That may be the right call this time, too. But as the losses pile up, it’s looking like it will be a harder and harder mantra for investors in these funds to stomach as the wisdom of the managers is called into question.

“I don’t think they have suddenly taken stupid pills,” Mendels, an adviser at Creative Financial Concepts in New York, said of Longleaf in a memorable quote from Stein’s story.

Hmm. Maybe it would’ve been better if they actually had taken stupid pills? Then they could solve this mess by simply stopping the stupid-pill regimen.

Instead, it appears to be more worrisome than that: Even the smartest investors can fall into a value trap. •

Michael P. Regan is an editor-at-large at Bloomberg News.

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