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Dreman: Chesapeake. Yeah. Chesapeake, we do own. Talking about stocks we own now, we have to keep only a certain amount that we can’t go beyond. We’re high in oil. We look at it.
Forbes: You still have BP?
Dreman: We have a little BP.
Forbes: That’s an example of your contrarian investing. You bought it when everyone else was fleeing the exits.
Dreman: Yes, actually. That, and Anadarko. Because Anadarko had a 25% interest in that well. Anadarko’s come back beautifully.
Cognitive Psychology
Forbes: Now, getting to psychology, what you call “cognitive psychology,” one of the factors that you discuss in the book, and I think you’ve mentioned in the past, Morningstar. That if you get a lot of stars from them, be careful. They’re looking at the past, not the future.
Dreman: Well, with all due respect to Morningstar, a lot of the consultants also have rearview mirrors, and they’re looking at these very carefully. I guess what we’ve got in the book on that is that a lot of the risk measurements simply, like the beta, have never worked. We all use it, every consultant uses it. But even the efficient market people have given it up.
Fama and French were two of the leaders in efficient market thinking, particularly Eugene Fama, wrote a paper in 1992 refuting Nobel Prize winner Bill Sharpe, who came up with beta, saying that it doesn’t work. And so they’re out looking for a new beta. I guess my question is if they’re looking for a new one, how are markets efficient for the last 40 years that used beta?
Forbes: One thing on psychology, which we’ve always known, is that every investor says they’re long-term – and they are until the market takes a hit. You showed your fortitude by taking a huge hit in 2008-2009, clients fleeing for the exits and the like, even though you came back in the latter part of 2009. How do you guard against the crowd reaction?
Dreman: Well, as a money manager, it’s very tough. Doing the right thing for your clients will often result in them leaving for you awhile. We had that happen to us during the Internet bubble, where we wouldn’t buy internet stocks and even some of our value competitors bought them.
We’d call in the meetings and the executive committees would say to us, “Well, look. It’s not that you’re trailing the market overall, but you’re trailing your competitors.” And we’d say, “Yes, but they’re loaded with these tech stocks.” And it hurt us, but then when the market turned the next year, I think one of our funds was up 42-43%, our major fund, when the market was down, 10%. So a lot of the business came back, and actually went up sharply from there.
But psychology has a very major role because – I think some of this is new work, although there’s been a Nobel Prize awarded to this work already, to Danny Kahneman and another to Vernon Smith – we’re just starting to find out what causes bubbles. There weren’t good answers until the last ten or 15 years.
And it’s just basically, again, the more we love companies, the more we’re willing to pay for them. I guess there’s a corollary to that, and that is that the more we like a company, the less risky we think they are. So in the Internet bubble, we would have loved these companies because we thought that Yahoo had no risk for it. Although it did go down slightly, something like 95% to the bottom before coming back.
There are rules here, I guess, that the contrarian strategy will help you with. That is, they’ll keep you out of these stocks. You’ll probably lose a lot of friends in the interim and be very upset by missing these gains. But the gains are very, very short-term, and the endings are never very happy.
High Frequency Traders Are Vulture Investors
Forbes: Let’s close on discussing your less-than-enthusiasm for high frequency trading. You shy away from the word “manipulation,” but you make the point politely that these folks accentuate the upside and accentuate the downside. And they make up now two-thirds of the daily average trading volume on the bourses around the world?
source: forbes.com
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