How to compete in investment markets

Francisco García Paramés and Tano Santos

On 6 June 2018, the Rafael del Pino Foundation organised the dialogue "How to compete in investment markets" with the participation of Francisco García Paramés and Tano Santos.

Francisco García Paramés is one of Spain's leading investment managers. With a degree in Economics and Business Studies and an MBA from IESE, in 1989 he joined Bestinver Gestión, a company belonging to the multinational Acciona, where he managed 10,000 million euros and reached the position of chief investment officer. He resigned on 20 September 2014, a departure that caused a great stir in the Spanish financial world. Self-taught, his management style is based on the strict application of the principles of the school of value investing, within the framework of the Austrian theory of the economic cycle, and he is considered a faithful disciple of Warren Buffett.

Tano Santos is co-director of the Heilbrunn Centre at Columbia University Business School. Professor Santos completed his PhD at the University of Chicago in 1996. From 1996 to 2003 he was a professor at the University of Chicago Business School, joining Columbia University Business School in 2003, where he currently holds the David and Elsie Dodd Chair in Finance. His research ranges from asset valuation to organisational theory. His publications include three articles in the Quarterly Journal of Economics, two in the American Economic Review and two in the Journal of Political Economy. Tano Santos reinforces CEMFI's academic team in the area of finance.


On 6 June 2018, the Rafael del Pino Foundation hosted a dialogue between Francisco García Paramés, investment manager, and Tano Santos, David L. and Elsie M. Dodd Professor of Finance and co-director of the Heilbrunn Center for Graham and Dodd Investing at Columbia University's Heilbrunn School of Business, on "How to compete in the investment markets. Dodd Professor of Finance and co-director of the Heilbrunn Center for Graham and Dodd Investing at Columbia University Business School, on "How to compete in investment markets. The present and future of Value Investing". When analysing the investment philosophy behind Value Investing, Tano Santos pointed out that it is a coherent integration between a company's valuation method and a deep knowledge of its business model. A second characteristic has to do with the efficient use of information, because not all information has the same value or should have the same weighting, as some things are more relevant than others. The third is a very different idea of what risk is, since the value investor is obsessed with the idea of preserving capital. The last is the constant concern about why, if the investor thinks a company is worth two hundred, the market thinks it is worth a hundred and gives him a chance to invest. This is something fundamental because what characterises the financial markets is that nobody ever has complete information. For García Paramés, value investing is what any successful investor has done for the last three or four thousand years. What has happened in the 20th century is that it has become more formalised, although it does not vary much from what has always been done. It is about trying to find undervalued assets, with a higher cash generation capacity than the market is recognising. Then you have to evaluate the information, understand why you think that asset is undervalued. Once you understand that, then comes the most difficult part of the process, which is buying. In all of this, we must always bear in mind that people have biases that make them make incorrect decisions, as well as the fact that they like to be in the herd. What a value investor does is to put these characteristics in his favour, with these cash discounts, with these valuations, and to know how to make the decision to invest. Tano Santos puts it differently. According to him, what the value investor wants is to have a valuation method that allows him to have the wind at his back. This method is designed so that the starting condition is that the wind is going to help because the investor knows where the risks are and takes positions so that if there are surprises, they will be positive. In this respect, García Paramés clarifies that there is not just one method of value investing, but many different ways of doing things. He thinks it makes more sense to buy companies with a P/E of 8 or 9 than with 15 or 16, because with the former it is easier to guess the future due to the shorter time horizon. When investing below PER 10, the investor puts the wind in his or her sails. Tano Santos explains that there are several ways to find investment ideas. The first is to sort the available assets according to a certain metric, such as P/E and earnings ratio, and analyse why they are undervalued when they have good earnings ratios, given that this set of assets offers good returns. The second is to look at what good investors do, copy the smart people who have experience in the sector they are buying. These people are constantly reading, not just the newspapers, but business and economic history because it contains a huge amount of experience of companies that have been successful. You learn a lot from these things because the essentials of a business change much less than you think. Finally, you have to go into the fire. When a country experiences a financial crisis, or a sector undergoes regulatory changes, there is enormous volatility from which business opportunities can arise. García Paramés adds that he likes to look at the stocks that have fallen the most every day, see what is happening there and then start to build a portfolio. When it comes to valuing a company, for Tano Santos the discussion about the business model is absolutely central. García Paramés, on the other hand, indicates that what you have to look at over time is the degree of confidence that the cash flows are going to be there. In most businesses the environment changes. There may be a barrier to entry that comes from the quality of the company in the environment, but that may change in the future. That quality is what gives the cash flow strength and quality. The essential thing about doing a competitive analysis is the certainty about the cash flow that we are going to use in our position and that the price to be paid for the company is reasonable. In this respect, Tano Santos qualifies that, on many occasions, it is difficult to see what the competitive advantage of a company is, but there are things that can be seen, for example, the stability of operating margins, which do not suffer with the economic cycle. For example, if the fraction of sales is stable in the overall fraction of sales in the industry. Or the knowledge that a company tried to jump the entry barrier of a market and could not. When you look at a great company and think about investing in it, you want to be clear about what those competitive advantages are, and you want to be clear about what multiple you want to pay for it. Also, when you talk about competitive advantages, it changes the idea of risk. The risk that one should be concerned about is any technological or regulatory innovation, etc., that compromises those competitive advantages. This methodology informs you of the risks you need to protect yourself from. In the same vein, García Paramés explains that it is a question of the risk being viable and the result beating inflation. Assuming there is no disruption, companies with a high competitive advantage have a much higher stability in results than those with a low competitive advantage, or commodities. With regard to the influence of the macroeconomy when it comes to investing, García Paramés indicated that it influences him relatively, because it depends on political factors that are normally unpredictable and, in the end, you have to choose stocks whatever the scenario, because it is difficult to predict what is going to happen. Tano Santos, on the other hand, believes that it is important to be alert to macroeconomic issues, to avoid investors being caught by surprise by a crisis, as happened to many of them with the international financial crisis. Macro information should be used to hedge risks. What is less clear is how to integrate it coherently into a portfolio or investment process. The second part of the dialogue focused on the changes that have taken place in the markets after the Great Recession. Tano Santos commented that there have been an enormous amount of regulatory changes that have resulted in a redistribution of capital to other less regulated agents, who are not prepared to do the things that banks have been doing for a long time and this is going to generate distortions. For example, the accumulation of cash in companies, due to regulatory changes, which has to be managed as if they were investment funds. In addition, active management has lost its reputation, notably and unjustifiably, while passive management, which is basically letting the machine do things, has grown. However, a certain amount of regulation does not take away the fact that you have to do what you have to do, which is to find undervalued assets, explains García Paramés. In some sectors, regulation has a greater impact and binds managers more. This bad image of the financial sector has led to the development of passive management because there have been abuses and excessive commissions, often hidden. We must also bear in mind that we are in eight years of a bull market. It remains to be seen what will happen when the first market swings and funds fall. At that point, says Santos, you have to have the mental fortitude to jump into the pool when everyone else is getting out of it and have the capital to invest. García Paramés adds that it is much easier to find value in those situations than to keep clients. For that reason, his fund manager does an educational job, explaining very well what they do, so that when those moments come, the client is reassured. As for the future of investment, García Paramés believes that passive management is here to stay, so we don't know what market share it will have. What passive management does is amplify trends, distortions and abnormal situations of undervaluation and overvaluation of assets. And Santos makes it clear that the returns from analysing the information have to go up, which is going to put a cap on how much passive management is going to go up. In this sense, investor activism is one thing that has to come to Europe in general, because it can be a source of high returns in an environment where returns are low. There are many institutional barriers to prevent this from happening in Europe, but it is a way to generate returns. Finally, they referred to the monetary policy measures adopted by the main central banks to combat the crisis. For García Paramés, the less monetary intervention, the healthier the market is. He also feels that, fortunately, monetary intervention has not been reflected in the real economy. So, if interest rates go up, the impact need not be too negative. We may come out of this without too much damage, he believes. At the same time, Santos adds that the monetary impact on yields has been somewhat exaggerated. Low yields respond to fundamentals such as issues of saving more in the long term by investing in assets, but the amount of assets traded in the world has not grown substantially, so there has been a substantial increase in demand, but not in supply. Why? Because there are highly leveraged companies that cannot issue and because new companies do not need capital, they do not need to issue anything. No paper is generated and you have to invest in what already exists, which generates relatively low returns.

The Rafael del Pino Foundation is not responsible for the comments, opinions or statements made by the people who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their sole responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio González, are the result of the debates held at the meeting held for this purpose at the Foundation and are the responsibility of the authors.

The Rafael del Pino Foundation is not responsible for any comments, opinions or statements made by third parties. In this respect, the FRP is not obliged to monitor the views expressed by such third parties who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their own responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio J. González, are the result of the discussions that took place during the conference organised for this purpose at the Foundation and are the sole responsibility of its authors.