Book Review – There’s Always Something to Do

Peter Cundill ran the Canadian Cundill value fund from 1974 – 2010 generating annualised returns of 13%. His investment style was firmly in the Graham deep value camp but through a global lens. He invested in European and Japanese stocks before it was popular to do so as a foreigner.

His investment style was especially focused on the balance sheet, searching for companies with hidden assets – for example land carried at cost on the balance sheet. This would artificially understate the book value of the company.

Since he invested globally, Cundill had a network of like-minded analysts who indirectly worked for him. They sent him investment ideas and he would use them to carry out scuttlebutt research. This was a great (cheap) way of generating new investment ideas in different countries.

The book is essentially a summary of his diary entries while running the fund. It is geared towards the emotional side of investing rather than the technical. Cundill writes about constantly questioning his investment thesis for an idea when things were going south and the importance doing the valuation work yourself so that you could have some level of confidence in the numbers, especially when the market thought otherwise.

The most important lesson I learnt from the book is however not what the author is likely to have intended. That is the limited scalability of deep value strategies. Peter Cundill was fundamentally a statistical deep value investor. That is low P/B stocks, distressed situations, companies selling below their net current asset values. In his first 10 years of running the fund, he invested in small, illiquid stocks. During this period, his fund generated annualised returns of 26% over 10 years while the MSCI World index returned 12.8% annualised. During his 36-year tenure, his fund annualised 13.5% while the MSCI World index returned 11.2% annualised. What caused this decline in outperformance relative to the benchmark?

Returns for most strategies invariably fall as the amount of money managed increases. As his fund became successful and AUMs grew, small illiquid stocks became a smaller part of his portfolio. Success forced him into larger cap and more liquid stocks. This is normal for any strategy that initially invests in small illiquid stocks. However, the transition is especially bad for a deep value manager for two reasons.

First, the size of your investable universe shrinks really quickly. Larger stocks are (generally) more efficiently priced. To invest with the same deep value strategy, Cundill was probably forced into some value traps where the low statistical valuation was hiding a deteriorating business.  If you buy a stock trading at a big discount to its tangible book value or net current asset value, it is statistically cheap and you have a margin of safety. However, if the company is losing money, your margin of safety is eroding. Time is not the ally of a deep value investor.

Second, intangible assets became a larger part of the global economy from the 1970s when Cundill started his fund. In America for example, about 85% of the companies in the S&P 500 were industrials, 10% utilities and 5% rail companies around this period. These are all industries with large tangible assets. Today, these industries account for less than 20% of the index. Tangible rich industries fell from being almost 100% of the index to less than 20% of the index. This means that other industries grew very fast in this period – mainly technology, healthcare, financials and consumer discretionary, industries with lots of intangible assets.

A deep value strategy investing in tangible rich companies over the last 40 years has therefore had to overcome two hurdles – limited participation in the growth of the intangible economy and a smaller investment universe of tangible rich companies to invest in, increasing the odds of investing in value traps. This is not to say deep value strategies don’t work – they do. However, a deep value fund with large AUMs will struggle to perform well because its size and investment style significantly shrinks its investable universe.

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