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Fields of experience – Value investing continues to stand the test of time and confound any critics

27/02/2014

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

Back in the 1960s, a number of Western agricultural scientists travelled to Lake Titicaca in the Peruvian Andes to study how the peasants there farmed their land – and returned home baffled by what they had found. “The peasants’ cumulative agricultural efficiency is so appalling,” they later wrote, “that our amazement is how these people even survive at all.”

What the scientists could not understand was the way the farmers chose to cultivate numerous small parcels of land rather than one large area, as would be more likely to happen in the west – particularly since this meant the farmers spent some three-quarters of every day just travelling from field to field. The scientists’ advice to the peasants was to wise up and consolidate their land holdings.

However, the issue was revisited by US anthropologist Carol Goland, who showed there was a good deal of method to what those earlier scientists considered madness. Crop yields, she pointed out, varied markedly from field to field and from year to year – and predominantly because of factors beyond the farmers’ control, such as weather, pests and theft by other people. This meant the farmers had no way of knowing which individual fields would do well in any particular year.

Goland calculated the farmers needed their land to yield about 1.3 tons of food a year to avoid starvation. If they had put all their land together, as those earlier scientists had advised, then it would have yielded around three times that amount in a normal year – but there was also a 37% chance that in any one year that single large field would suffer bad weather, pests and so on and the farmers would starve.

By contrast, their traditional practices rarely yielded more than two tons of food per year, but the chances of the harvest dipping below the ‘starvation’ level were very small. In other words, the farmers had developed a system that confounded western wisdom but which was actually a very durable and sustainable way of surviving in their environment.

From both an investment and a more value-specific perspective, there are a number of lessons to draw out here – probably the most obvious of which is that, whether you are managing a farm or a portfolio, you ignore diversification at your peril.

A second point would be that, in order to achieve something good in the long term, you often have to make shorter-term sacrifices. The Andean farmers spent much of their day ‘unproductively’ walking between fields, but by doing so ensured they had a highly sustainable food supply. Similarly, for value investors, accepting that investment performance may be difficult in the shorter-term is part and parcel of achieving the attractive long-run performance that the style can give.

A third lesson would be that in investment there is always some supposed expert out there who will tell you that tried and tested techniques – such as buying cheap companies with strong balance sheets – are outdated and to do things differently. Most of the time these ‘experts’, will be wrong. Just because they are able to quote some new and exciting-sounding process or theory that supports their view, does not mean they have to be right.

That leads neatly on to one final point – strategies that have delivered the goods over long periods of time should not be abandoned readily for those that have been around five minutes. Ways of doing things tend to stand the test of time because they either offer a particular advantage or they lack disadvantages. The longer the periods, over which they have been tested, the higher the bar should be before we give them up.

The benefits of value investing can be observed in well over a century of data – arguably the only distinct investment style about which that can be said – and investors should be as cautious to abandon its key tenets as the Andean farmers were to change the way they farmed their land.

The story of the Peruvian farmers is taken from the book “The world until yesterday” by Jared Diamond.

Author

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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