To understand Ibbotson's ideas, an intuitive example is useful. When investing in an apartment, look for an unpopular neighborhood in the city, but one that is not in decline. Find a well-built home. When this urban area starts to be fashionable and people talk about it, sell your property, keep the capital gain.
This Yale University professor, director of the Zebra Capital Management fund, has achieved above-average returns by systematizing the popularity criterion applied to finance, which he conceived in 2007. In the academic world he sounds like a possible Nobel Prize winner. He was recently in Barcelona for the launch of the GVC Gaesco Zebra US Small Caps Low Popularity fund. Jaume Puig, the general director of this manager, defines Ibbotson's theories as "the bridge between classical financial analysis and behavioral economics."
From when can you say that a company is known?
One of the ways we measure popularity is how much business value it has relative to the capitalization of the company. It's somewhat related to liquidity, because if the stock is traded a lot, there is a lot of interest in it. Then there are other measures, like seeing how much appears in the news.
And then, according to its metrics, if the company is small and unknown, it has points to be a good investment.
It's that easy. If a company provides a certain amount of cash flows, people are interested in it and there is a lot of demand, its price rises. But if investors overlook it and don't seem to know the company, it is priced lower, allowing for a higher return.
But these small companies are often somewhat opaque and less controlled. They are a risk.
But they are the ones that end up having the highest ratings. Basically, these are often companies that most of us have never heard of. Then there are small but well-known companies. You go to a cocktail party, people talk about some stocks. Then investors get excited and then they become fashionable. What we do is focus on the ones that no one knows about. When their popularity rises, then we sell them. On average they stay in the portfolio for one year. The most important thing is to avoid the most popular stocks, because they earn much lower returns in comparison.
Warren Buffett joined Apple a few years ago and it hasn't gone that bad either.
I'm sure he knew a lot about Apple before making the decision, something little known. There are managers who buy shares of companies they know simply to complete their portfolios. I am not referring to Buffett, who has had great returns especially investing in firms or sectors that were not fashionable at the time, such as railroads.
But if they are not well known, there must be some reason, right?
If there is something wrong with the company and you don't know what it is, but other people do, then this could hurt your strategy. But what often happens is that companies that have a problem make some change in management and it is something that makes them improve. They make profits and become popular.
What if a recession comes now, as some analysts suggest?
These securities are not likely to be hurt much in a recession because these firms typically do not need capital and do not have to pay higher interest rates to finance themselves. Stocks of firms that are less popular tend to be, to some extent, more traditional companies. They already have profits. In fact, their operating margins are much higher than the rest.
Its strategy practically excludes startups
Is it enough for a company to do it well for it to become popular?
It's difficult to keep improving. Not only do you have to improve, but you have to improve more than people think you are going to improve. It's a matter of expectations. It often happens that a company collapses. It begins to set very high objectives, similar to those of the most established firms. In the end, some do not achieve those goals. Then they start to become less popular. On the other hand, if investors have a bad opinion of the firm at the beginning, it is easier for it to improve.
Markets can be wrong. Popularity can be deceptive.
Markets are mostly irrational. It's noisy. One of the reasons we focus on small caps is that information is less available in this sector and people have less time to study it. They are away from noise.
Is this criterion when investing applicable to other asset classes?
Yes, it can be applied to real estate. Although I'm not so sure about real estate, because there are cases where unpopular urban areas end up getting worse and worse. They are less efficient markets than the stock market: there are delivery times, construction times, it is more difficult to speculate, you have to pay commissions and to obtain profits you have to sell very expensively, while with shares you have more ability to operate. It is also more difficult to manage a European small-cap portfolio than a US small-cap portfolio, because securities in Europe are less traded.
And does the same thing happen with fixed income?
Bond interest rates were low for a long period of time, even though inflation seemed to be coming. Negative real interest rates were even paid. What does it mean? You have to really like something to get a negative real rate, right? In short, bonuses were very popular. In fact, the bond market is an interesting place because you can measure its popularity. You can see it in the bond spreads between one bond and another. When it's really popular, the spreads are tight. When it is not, the risk premium increases.
Professor, I see that you are on the front line and that you do not plan to retire.
I think managing people is much more complicated than managing money. Of course, things fluctuate and there are ups and downs and you can't control everything that happens in the field of investing. But you can do the best you can and it's nice. When you manage people, on the other hand, you make a lot of stupid mistakes all the time.
