Each year hundreds of portfolio managers describe their investment philosophies, processes and portfolios to our research team. During many of these conversations, portfolio managers will often pull out a Warren Buffett quote to fortify their view on a particular topic. It’s a very common practice, and a safe one too, as who can argue against Warren’s wisdom and track record? In turn though, whom does Warren Buffett usually quote? Benjamin Graham.

"Father of Value Investing"
Benjamin Graham was one of the most influential figures on Wall Street. Although other notable value investors including Bernard Baruch predate Graham, his systematic approach revolutionized security analysis and is the reason why he is considered to be the “father of value investing”. His books “Security Analysis” and “The Intelligent Investor” are still often considered the most important texts for both individual and institutional investors.

Benjamin Graham was born in 1894 as Benjamin Grossbaum in London, but moved to the United States and grew up in New York City. He graduated from Columbia University, and taught at their Graduate School of Business from 1928 to 1957.

Why Graham Matters To Us
I am originally from Nebraska. Though I grew up in a small town, I heard and learned quite a bit about the “Oracle of Omaha”, Warren Buffett. Because of this influence, alongside such basic influences as how I was raised and what I learned from teachers and experiences, I gravitated toward the “value school of investing” as opposed to other investment philosophies.

Eric Kobren meanwhile, earned his MBA from Columbia University – the school of Benjamin Graham, Warren Buffett, and many other value-investing luminaries. Eric earned his undergraduate degree from Bernard Baruch College, the namesake of the famous value investor who made his reputation by predicting and cashing out ahead of the 1929 stock market crash.

In combination, it’s not a stretch to see why Eric and I tend to favor value-based strategies and why the thoughts and practices of Benjamin Graham resonate in what we say and do here at Kobren Insight Management.

Weekend Reading
Recently, I began to re-read Benjamin Graham’s classic book: “The Intelligent Investor”. I already own two editions (it has now had five editions since it was first published in 1949), but I heard enough good things about the 5th edition, including some additional and insightful commentary from financial journalist Jason Zweig, that I sprung for another copy.

As I was re-reading some passages from the book, I felt that some of the Jason’s comments would be useful to share with you as I think they provide some additional insights into how we manage your money.

To be consistent with other portfolio managers, here is my obligatory Buffett quote that happened to preface “The Intelligent Investor”: “I read the first edition [of The Intelligent Investor] early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.

To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

Graham’s Core Principles
According to Jason Zweig’s commentary, Graham developed these core principles:

• “A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.
• The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.
• The future value of every investment is a function of its present value. The higher price you pay, the lower your return will be.
• No matter how careful you are, the one risk no investor can ever eliminate is the risk of being wrong or early. Only by insisting on what Graham called the ‘margin of safety’ – never overpaying, no matter how exciting an investment seems to be – can you minimize your odds of error.
• The secret to your financial success is inside yourself. If you become a critical thinker who takes no Wall Street ‘fact’ on faith, and you invest with patient confidence, you can take steady advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.”

My commentary on the above notes and how they pertain to what we do at KIM:

• Investing is a serious endeavor, not a game. We take this responsibility seriously and treat the money you entrust to us as if it were our own. In fact, we “eat our own cooking,” investing significant assets right along with you.
• Success generally follows those investors who do not follow the herd and are able to take contrarian, or unpopular, investment decisions.
• Valuations matter. Graham did not feel that one should buy popular stocks. He felt that stocks should be bought like groceries, not like perfume.
• Diversification is critical; even the greatest investors such as Graham were often wrong. We maintain balanced, diversified portfolios.
• Patient, long-term investing is more important than monitoring and worrying about monthly or quarterly returns. We will not speculate in an attempt to generate short-term gains.

Investment Advisors
According to Graham, an enterprising investor is one who has the time, knowledge and temperament to realistically seek superior investment returns. In the absence of those traits, one should be “defensive” or hire an investment advisor. And the main benefit of hiring a professional advisor, Graham argued, was to protect the investor from costly mistakes -- not to specifically beat the averages.

He also believed that most individuals who invested in mutual funds have done better than what they otherwise would have done on their own. Graham felt that if an investor did not invest in a professionally managed portfolio, that “untoward influences” would often incline that individual toward speculation – which he believed was the best way to lose money in the markets.

In the end, Graham believed the only legitimate function of an investment advisor was to help investors obtain a good value for their money, by using value-oriented and risk-controlled diversified portfolios -- not to make clients rich quick.

Enthusiasm in the Stock Market Is Dangerous
“…That while enthusiasm may be necessary for great accomplishments elsewhere, in Wall Street it almost invariably leads to disaster.” Enthusiasm destroys critical faculties and leads people to believe in “sure things.” As a result, we tend to bet heavily, forgetting the legendary Bernard Baruch’s warning that every investment is something of a gamble. Enthusiasm often leads into speculation, which Graham strongly discouraged.

Benjamin Graham on Asset Allocation
“We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds. There is an implication here that the standard division should be an equal one, or 50-50, between the two major investment mediums.”

Ah, a very rich paragraph. It should be noted that our “neutral” allocation to equities in our most conservative accounts is 25% equities while our neutral allocation to stocks in our standard growth portfolios is 75% (of course we do have more aggressively positioned portfolios if it is appropriate for a particular client’s situation). Our balanced portfolio indeed has 50% in equities. Thus, our allocations are in line with Graham’s classic thinking.

In this current day and age, most people start off with a growth, or equity-dominated portfolio, as the default option, then adjusting a bit depending on circumstances. This is likely a result of the strong returns over the last twenty years that most investors still expect moving forward. Graham (as well as many current market luminaries) however, believed that the standard portfolio for most people should be the balanced portfolio -- evenly split between stocks and bonds -- and then adjust from there if necessary.

There are some differences between Graham’s views and our own, however. He saw the investment universe as consisting of two basic asset classes: high-grade stocks; and bonds. Since then, the opportunity set for investments has broadened considerably. Here at Kobren, we look at the world as more “equities” and “non-equities.” Non-equities are any asset classes that we can use to diversify equity holdings. Non-equities can consist of bonds, as well as cash and alternative investments such as real estate and commodities.

Another item to point out is that Graham believed that adjustments in the basic asset allocations should primarily be driven by market valuations. While we agree with his view that relative and absolute valuations should influence asset allocation, we don’t quite share the same degree of emphasis. We believe that strategic adjustments to asset allocation should be driven by personal circumstances such as current financial conditions and goals, risk tolerance, time horizons, and other personal considerations. While more modest tactical changes in allocations should be driven by valuation changes.

The Tip Of The Ice Berg
Benjamin Graham’s contributions to security analysis go far deeper than the excerpts I’ve discussed. I never even touched upon some of his more notable concepts such as “Mr. Market” and “Margin of Safety.” But I do think the examples I highlighted provide useful insight into how he has influenced our investment thinking, and how that translates into they way we manage your money.

As I finish my re-read in the weeks ahead, I may well share some additional thoughts on this legendary investor -- and teacher of legendary investors. Stay tuned.