Active Value Investing

Katsenelson, a money manager at Investment Management Associates, argues that long secular bull markets are followed not by bear markets but by extended range-bound markets, and that the strategy appropriate to a range-bound market differs from buy and hold.

The historical claim comes from examining American equity market history in long segments. He identifies periods such as 1966 to 1982 and 1937 to 1950 where the index went essentially nowhere for many years while experiencing large swings within the range. His explanation is valuation rather than earnings: secular bull markets end at high price-to-earnings multiples, and the subsequent period consists of earnings growing while multiples contract, which produces flat prices. He argued in 2007 that the market was in such a period, having peaked on valuation in 2000.

The strategy he proposes is what he calls active value investing: buy quality companies when they are cheap within the range and sell them when they approach fair value rather than holding indefinitely, because in a range-bound market the multiple expansion that rewards holding does not arrive. He sets out a framework he abbreviates as quality, valuation and growth, requiring high returns on capital, competitive position and balance sheet strength on the quality side, an explicit valuation discipline with a sell target, and growth assessed conservatively. He is explicit that this raises turnover and tax cost relative to buy and hold and argues that the range-bound environment justifies it.

The framework's central prediction was reasonable when written and the period from 2000 to 2013 fits it. The subsequent decade, in which multiples expanded again and buy and hold outperformed active selling, does not. The book also does not resolve how an investor identifies which regime they are in except after the fact, which is the binding practical problem.