If the adage of value investing is “buy 'em when there is blood in the streets”, then value investing is inherently difficult. It means doing things will make you truly queasy. What’s more, classic value investors tend to be early and will suffer early losses before their investments turn profits.
With those thoughts in mind, let’s look at what broad themes there are that would make the stomach turn:
Junk or just non-AAA fixed income paper for the patient money: In some of these markets there are no bids, which would make it ideal for an investor with a long time horizon and the ability to analyze bond covenants. This story explains some of the structural problems with this kind of paper and the opportunities associated with them. Key quote:
But it looks like now could be the time for big and patient investors (such as Warren Buffett) to start snapping up relatively good-quality credit.
Bottom-up systematic, or equity quant investing is out. There was something comforting about systematic quantitative investing. You had all these tools and could look back at history to see how different techniques performed in past markets. What's more, it was highly risk controlled. Over time, the barriers to entry to using these techniques came down and it became too easy to run these strategies. In August 2007, virtually all quants suffered large losses. They were in a crowded trade and someone ran for the exit (see here). So let’s try something different.
How about top-down macro discretionary investing? People who can spot long-dated investment themes and have the strong temperment to bet on them are worth their weight in gold (warning: their results can be volatile). Find a manager like Ken Heebner, who was prescient about the fall of housing and thought that the housing could collapse by 50% in selected markets. Another is Eric Sprott in Canada, who was early to jump on the commodity bandwagon. I mention them to show examples of portfolio managers who display a top-down, analytical but non-quantitative systematic style of investing (and not to endorse either Heebner or Sprott).
If quant investing is out then maybe good old small-cap fundamental analysis is in. Fundamental analysis can shine in the smaller capitalization part of the market, where having managers and analysts who really understand what drives companies give them a bigger edge. However, I may be very, very early on this theme as the small cap cycle may have turned.
How about buying the US Dollar for a trade to turn your stomach really queasy? The deteriorating fundamentals of the US Dollar are well known and I believe that the currency is in a long-term bear market. However, when stories like this appear the Dollar may be poised for a rally and fool all the bears (and smack all the commodity bulls around too). Be careful - if you time this wrong this trade isn't like catching a falling knife, but falling boulders with knives sticking out of them.