Silver lining

Attendees at last month’s annual meeting of the Templeton Growth Fund found tucked
in their loot bags a glossy sheet of sage investment advice from the fund’s founder,
Sir John Templeton.

Sir John passed away a couple of weeks before the meeting at the ripe old age
of 95. But his value approach to stock selection continues to form the basic
philosophy of the group that bears his name, which is now part of the Franklin
Templeton empire.

So it was hardly surprising that that hundreds of people at the fund’s annual
meeting in Toronto’s Roy Thomson Hall were treated to a retrospective of his
career and left with a page of his financial homilies to ponder as they read
the latest depressing news from the markets. Among them:

“Too many investors focus on outlook and trend; therefore more profit
is made by focusing on value.”

“In the stock market, the only way to get a bargain is to buy what most
investors are selling.”

“To buy when others are despondently selling and to sell when others are
greedily buying requires the greatest fortitude and pays the greatest potential

As I have pointed out before, these are difficult times for value managers.
The bull market that began in late 2002 was largely commodities-driven, especially
in Canada. However, value investors, by their nature, tend to downplay commodity
stocks because of their cyclical nature. As a result, most have lagged behind
the growth and momentum managers in recent years.

Look at the flagship Templeton Growth Fund, for example. On the flip side of
the page of quotes from Sir John was a depiction of the fund’s famous “mountain
chart”, showing how $10,000 invested in 1954 would have grown to almost
$6.3 million as of May 31 of this year. It looks impressive at first glance
but on closer scrutiny an alert investor might be moved to ask: “But what
have you done for me lately?”

The short answer is: “Not much”. The fund lost 16.6 per cent in the
year to June 30. Over the past decade, the average annual compound rate of return
is a meagre 1.5 per cent. To be fair, the rise of the loonie was a major factor
in these dismal results. In U.S. dollar terms, the fund looks a lot better with
an average annual gain of 5.1 per cent over ten years and 12.2 per cent over
the past five.

So what do you do if you are organizing an investment extravaganza under these
conditions? Simple: you refocus on the core words of Sir John’s philosophy:
“Buy low.” Speaker after speaker talked about on the great bargains
they are finding in today’s markets.

“The world is not coming to an end,” reassured Templeton Growth Fund
manager Lisa Myers. “Times of uncertainty are also times of opportunity.”
Price to earnings ratios in key world markets are near their 20-year low, she
said. Top-quality companies like Microsoft, AIG, Merck, Oracle, Vivendi, and
Siemens are on offer at discount prices.

The notable absentees from the financial bargain basement include China, Brazil,
and Canada, all of which enjoyed a strong run in recent years. But now they’ve
become overpriced, so it’s time to shift gears, Myers says. Templeton Growth
does not have significant positions in any of the three countries, choosing
to zero in instead on the U.S. and the U.K.

Despite the recent weak results, the logic makes sense especially here in Canada.
The TSX has enjoyed a great run but it was largely fuelled by three sectors:
financials, energy, and materials. The fallout from the on-going subprime mess
has knocked the stuffing out of the financials. Energy stocks pulled back when
the price of crude oil turned down. Materials shares have lost some of their
lustre. Without at least one and preferably two of those groups providing a
lift, the TSX appears destined to struggle for a while.

So the Templeton message of global diversification combined with their buy
low and be patient approach makes sense. But you must be prepared to stay the
course. That may mean enduring more losses for a while, although you can reduce
that risk by moving some assets into bond and money market funds. The markets
will turn and value investing will come back into favour at some point. When
that happens, the bargains that Lisa Myers and her colleagues are finding today
will translate into strong returns. But no one can predict when that will be.

“Bull markets are born on pessimism,” Sir John said. What he did
not tell us was the length of the gestation period.

Photo © Crosthwaite