Kraft-Unilever Deal Is Off, but Warren Buffett's Anomalies Live On
February 20 2017 - 4:14PM
Dow Jones News
By James Mackintosh
The story of Kraft Heinz Co.'s takeover bid for Anglo-Dutch
consumer-goods giant Unilever is short, having lasted from Friday
only to Sunday. But behind it lies a tale of market anomalies that
have lasted decades, helped make Warren Buffett's fortune and may
-- perhaps -- have ended in a mini-bubble last year.
Mr. Buffett is renowned as a savvy "value" investor. But much of
the billions made by the Sage of Omaha at Berkshire Hathaway was
earned by exploiting two market mistakes: the tendency for quality
companies and low-risk stocks to outperform.
There are many ways of measuring the anomalies, and Kraft Heinz
and Unilever fit all of them. They are high-quality companies with
predictable earnings and strong cash flow, whose shares have
lower-than-average volatility and move less closely in line with
the market than the norm -- in the jargon, they have lower beta.
Kraft is piled high with debt, and Unilever is not, but investors
bought into both of their stories last year.
The big question is why such stocks outperform, and so whether
they will continue to do so.
The explanation for last year's performance is pretty clear.
Rock-bottom bond yields pushed many investors to buy stocks paying
steady dividends instead, and there is a big overlap between
measures of low volatility, high quality and a secure dividend.
The result was a stunning performance from those exploiting the
anomalies, followed by a snap-back when the fervor for dividends
subsided. MSCI's minimum-volatility index did fabulously well until
July, then turned around. The pattern for low-beta stocks was
similar, while quality stocks had a hard time keeping up with the
rebound in highly indebted oil-related stocks.
Ryan Taliaferro, who runs managed-volatility portfolios at
Acadian Asset Management in Boston, says the market was distorted
by exchange-traded funds that try to exploit these anomalies. At
one point he calculated that the stocks in the minimum-volatility
index were significantly more expensive than similar stocks not in
the index. "That felt kind of bubbly," he says.
Last year's boom-bust pattern is unlikely to be repeated, but
there are two competing explanations for the longer-run performance
record of safe stocks.
The first is about human behavior. Investors like to get rich
quick, like to gamble and have too much faith in their own
analysis, so stocks that look like lottery tickets are particularly
appealing. High-volatility and more market-sensitive (in the
jargon, high-beta) stocks should be overpriced as a result, and so
deliver lower returns in the future. So long as get-rich-quick
investors remain ignorant of the mistake they are making, the
anomaly will continue for everyone else.
The alternative theory is about leverage. Leverage can be added
to the safest stocks to bring them up to the same level of risk as
the wider market and deliver higher absolute returns. Mr. Buffett
found a smart way to gear up using an insurer, but many investors
prefer to avoid leverage because of drawbacks such as margin calls.
Others are prevented from borrowing by investment mandates. Those
who can't use leverage chase higher returns by buying inherently
riskier stocks instead -- the same ones that appeal to the
get-rich-quick investors. Again, the anomaly remains.
There is something in both explanations, according to a new
paper by Cliff Asness, Andrea Frazzini and Lasse Pedersen of fund
manager AQR and Niels Gormsen of Copenhagen Business School.
Investors don't like or can't get loans, and prefer
"lottery-ticket" stocks.
This is where we come back to Mr. Buffett and Kraft. Kraft is
the embodiment of a strategy to exploit both anomalies: It is a
high-quality underlying business but no longer especially low
volatility because it has been loaded up with debt. Unilever
doesn't have the debt, so it is still a quality, low-volatility
stock.
Mr. Buffett's extraordinary investment record rests on the same
principles, according to an earlier AQR analysis by Mr. Frazzini
and colleagues. They found that Mr. Buffett's preferences for safe
and high-quality stocks "almost completely explain the performance
of Buffett's public portfolio," once leverage was accounted
for.
Kraft has walked away from Unilever, but investors should be
keeping an eye on the sheer amount of money now dedicated to these
anomalies. The more cash chasing them, the less powerful the
anomalies will be.
"It's something to worry about," says Prof. Pedersen. "I think
as awareness of these effects increases that could certainly
diminish the returns."
It's hard to track the amount of money investors have dedicated
to exploiting the anomalies, and impossible to establish how much
leverage is used. But valuation offers one proxy, because safer
stocks and higher-quality stocks ought to be worth more than risky
ones or lower-quality ones.
As investors have tried to exploit the anomaly, valuations have
indeed risen. MSCI's USA Minimum-Volatility Index has a higher
price-to-book and higher forward price-to-earnings ratio than the
wider market. California-based Research Affiliates calculates that
at the end of last year the valuation premium for a low-volatility
portfolio above the wider market was about as big as it has ever
been. The valuation premium for quality stocks depends on how
quality is measured, but on RA's own metric it is above the
historic average.
Kraft's bid suggests Mr. Buffett and his private-equity partners
3G Capital think there is more to go before the anomalies are
played out. For many investors, Mr. Buffett's view is enough.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
February 20, 2017 15:59 ET (20:59 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
Unilever (NYSE:UL)
Historical Stock Chart
From Apr 2024 to May 2024
Unilever (NYSE:UL)
Historical Stock Chart
From May 2023 to May 2024