An Old-fashioned Investing Approach Still Shines

Tribune staff reporter

They came to Chicago from every corner of the globe--pension fund managers, endowment managers, money managers of various types--worried that they will disappoint clients over the next few years with lackluster returns from lethargic stocks and bonds.

They have been humbled by a 45 percent drop in U.S. stocks during the 2000-02 bear market and by puny interest rates in bonds. With prices on investments from commodities to real estate and many stocks stretched to high levels by easy money flowing throughout the world, their training tells them they can't expect vibrant returns in the near future.

It has left many pension funds far short of the money they will need to pay retirees. It also has caused plenty of money managers to do a tap dance in front of clients still smarting from the bear market and demanding high returns plus security.

So, for a week, cutting-edge investment thinkers drawn together by the CFA Institute tried to acquaint the pros with that extra something to build a little spark into portfolios without sinking them. The tools: foreign currencies, derivatives, picking through commodities, selling stocks short, a broader world view, private equity and formulas for excising risks out of the stock market.

It was as though a simpler era had come and gone. Uncomplicated portfolios of stocks and bonds were starting to look like the Model T, unreliable and so passe, in need of new genius that would use complex computer models to slice and dice the market, extract risk and then add little morsels of energizers back into the blend. The word of the day was "alpha," the industry's favorite buzzword for the benefit investors get from investment brainpower, rather than the basic return the stock market provides without any prodding or fancy footwork.

If this sounds complex, it is. It's the stuff hedge funds are made of. It's the stuff that is making consultants and quantitative-tool designers fortunes as they promise to throw lifesavers to pension fund managers in a tizzy over the possibility of 7 percent or 8 percent returns over the next decade. And it's the stuff Wall Street is brewing into ever more complex exchange-traded funds and mutual funds for the masses.

As the pros explained the strategies, I couldn't help but wonder how everyday Americans, relying on their own skill to manage 401(k)'s and individual retirement accounts, could ever survive in this high-tech, esoteric investing world. In fact, I wasn't sure how most of the people they turn to for advice would handle the whiz-kid models, especially as Wall Street tires of pedaling its gizmos only to institutions and turns its attention increasingly toward Main Street money managers and financial planners.

Then came a reassuring, romantic figure from olden days: John Neff.

Neff was the legendary manager of Vanguard's Windsor Fund. In 31 years as a portfolio manager he beat the Standard & Poor's 500 index 22 times. He didn't worry about "alpha." He provided it the old-fashioned way, examining companies with a fine-toothed comb, making sure he bought them so cheaply that even if he was wrong about future profits he had built in a margin for safety.

So what is Neff's solution for investors in the years ahead? The same as always: Buy low, sell high.

In an era in which there are plenty of newfangled products on the market, Neff said the same approach that made him a mutual fund star has continued to work for him as he has managed his own funds since retiring in 1995.

He said he has averaged about a 20 percent annual return during his retirement. Over that period, the S&P 500 index averaged about 8.3 percent.

One of his favorite stocks now is Citigroup Inc. He said the stock is so inexpensive that investors are paying for its growth and then getting the dividend virtually for free. Neff always has stressed dividends in his stock picks. He also selects stocks priced at a 40 percent to 50 percent discount to the S&P index.

Besides the price, Neff likes Citigroup because it does so much business in emerging markets. "It's a lazy man's way to participate in emerging markets," he said.

As for hedge funds, Neff said they charge investors too much and then "operate with gang warfare." As too many chase the same strategy, "If they are wrong, they will go belly up together," he worries.

If the Windsor fund had been charging the type of fees that hedge funds charge, he said, it would have provided investors with an average annual return of 11.2 percent rather than its 13.9 percent. That would have barely exceeded the index.

He also is skeptical of predictions that oil is going to $100. He remembers the 1980s, when investors "wanted every stock ending in `tronix,' and oil was to go to $100."

He suggested one reason why professional money managers are suffering lackluster returns is because they are afraid to chart their own course. They buy the stocks that make up an index, and they do it in the same quantities as the index holds.

That keeps them from getting flack because they can point to the index and say they did no better, and no worse. In investing, lagging an index is punishable by firing.

Neff said, as a manager, he continually received poison-pen letters because investors disagreed with the stocks or strategy he was taking.

For example, in 1987, just before the market crashed about 20 percent in a day, he could find no stocks cheap enough to buy, so he kept 20 percent of the portfolio in cash. Managers are reluctant to hold cash because they can't compete with the S&P 500 if it does well while they hold a smaller exposure to stocks.

Neff said his strategy worked perfectly in 1987, allowing him to buy stocks cheaply when they plummeted.

Currently, he said he's not having trouble finding cheap stocks and has found companies such as cargo transporter YRC Worldwide Inc.

Of course, he's an individual investor now rather than a fund manager. So there is one thing that he does differently: "I buttress my stocks with 30 percent in fixed income in case the wolf shows up at the door."

Contact Gail MarksJarvis at or leave a message at 312-222-4264.

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