Philosophy and HistoryAn Introduction to Value Investing"We don't follow the investment crowd. Instead, we search for overlooked opportunities Benjamin Graham – widely recognized as the father of value investing – believed that, in the short term, the markets were a voting machine, with a security's price reflecting its popularity on any given day. In the long term, however, Graham believed the market was more of a weighing machine, aligning a security's price with its "intrinsic value," or the true worth of the issuing company. For value investors, this means that a security's price and its intrinsic value often detach from one another in the short term. Because of the manic-depressive nature of the overall market – where sentiment can shift between sweeping, carefree optimism and overwhelming fear and uncertainty seemingly overnight – security prices tend to fluctuate much more than the true worth of the companies they represent. This irrationality can materialize on the upside, helping to lift prices to dangerously lofty heights. It can also appear on the downside, helping to drag prices to bargain levels. Value investors target the latter situation, seeking to purchase out-of-favor securities that are trading at discounts to their intrinsic value estimates, and then holding them until the market recognizes their true worth. By confidently approaching the short-term vagaries of the market with rational, objective analysis, we aim to identify compelling investment opportunities and deliver competitive long-term results. As Graham put it, the market "... often goes far wrong, and sometimes an alert and courageous investor can take advantage of its patent errors." The Importance of the Margin of Safety & a Long-Term Perspective "We believe the gap between purchase price and intrinsic value offers a margin of safety. In his investment guidebook The Intelligent Investor, Benjamin Graham challenged himself to "distill the secret of sound investment into three words." The three words Graham chose were "margin of safety." What does this phrase mean? Simply put, the margin of safety represents the difference between the price of a security and its intrinsic value estimate. Value investors believe that the larger this margin, the safer the investment. By identifying and purchasing stocks and bonds trading at what we believe to be substantial discounts to their estimated intrinsic values, we aim to build portfolios that can accommodate future uncertainty and demonstrate resilience in market downturns. Some holdings will inevitably encounter a stumbling block, and a margin of safety can provide protection if the going gets tough. When it comes to results, value investors emphasize the accumulation of lasting wealth over the pursuit of potentially fleeting short-term gains. Accordingly, we expect to realize significant profit as the market recognizes the true worth of our purchases. We acknowledge that this process often takes time. As a result, we exercise patience and manage our holdings from a long-term perspective. Typically, we expect to hold a security for as long as two to five years. While the essentials of value investing are simple, the process of appraising value and risk is complex, and a full explanation is impossible in this brief summary. For a thorough understanding of both principles and process, see the third edition of Value Investing Today by Charles Brandes, published in 2003 by McGraw-Hill.
Value Investing at Brandes Investment Partners®
The professionals at our firm possess a resolute belief in the benefits of value investing. This belief permeates all aspects of our business - from senior-level strategic decisions to the daily interaction each of our colleagues shares with clients and financial advisors. COMMITMENT: Philosophy We consistently apply the value investing philosophy in all market conditions - and to the portfolios we manage. We firmly believe investment success is driven by the identification and purchase of securities trading at discounts to their intrinsic value estimates. In our opinion, the benefits of this approach are evident in the long-term results we have achieved. COMMITMENT: Independence Organized as an employee-owned firm, we have maintained our independence since our inception in 1974. Our autonomy enables an unwavering focus on value investing, which we believe is in the best interests of both our clients and our firm. While independent, we have maintained a culture grounded in teamwork. Because of our shared beliefs, singular focus, and commitment to working together, we have built an organization characterized by stability, high morale, and continuity of business practices. COMMITMENT: Clients Our steadfast dedication to exceeding client expectations, in terms of both performance and service, guides everything we do. We strive to deliver superior investment results - and to maintain long-lasting, trust-based relationships with clients and financial advisors. Indicative of our commitment to client interests, we have closed strategies to new investors to help preserve the integrity of our investment process. As our firm grows, the best interests of our clients remain our top priority. Investment Process Equity Process Because we don't want to miss a potential opportunity, our search for undervalued stocks begins at a very broad level. As global investors, we literally have a world of investment possibilities on our plate. Our first goal is to narrow this field to a manageable number of prospective candidates that deserve thorough, in-depth analysis. We start by using computer databases to screen more than 5,000 companies across the globe. Characteristics we focus on at this stage include price-to-earnings or price-to-book ratios, liquidity, and market capitalization. To ensure our investment search is exhaustive, we also review third-party research and monitor news feeds such as wire services and the financial press. This persistent screening yields potentially undervalued companies that deserve a thorough examination. As a result of our screening process, these companies tend to have similar traits, including low valuation ratios and low levels of debt. Often, these companies are also out of favor and have stock prices that have been depressed by recent developments. In other cases, a company might simply belong to an unexciting industry that the investment community has largely ignored. To get to the bottom of each of these candidates, we thoroughly review them, one by one. Our analysts first apply the principles of our investment philosophy to determine an estimate of each company's value. Then, analysts formally present the most compelling opportunities to our firm's investment committees, where the purchase decision is made. In practice, the analysis stage of our stock selection process is quite intensive. We draw on everything from published financial statements to personal company visits to gain a comprehensive understanding of each business we review. Each of our analysts specializes in a particular industry, and we believe that concentrated focus allows them to shed even more light on the companies they evaluate. The analyst's goal is to be a knowledgeable expert on every company he or she covers. The investment committees, which include senior investment professionals, are the ultimate example of our team-oriented investment process in action. After analysts present their company reports and answer any questions posed by committee members, the team decides which companies will enter our portfolios. As a result, no single individual is in charge of purchase decisions -- instead, the entire team participates in the decision-making process. The committees also set buy and sell price targets, security-by-security weightings, and diversification constraints. Decisions are implemented firmwide, in accordance with each client's account guidelines. Our mutual fund portfolio management team implements the investment committees' decisions in accordance with the fund's guidelines. The Brandes Institutional International Equity Fund typically consists of 35 to 85 securities, with turnover typically averaging 20% to 40% per year. Importantly, the weights for sectors, industries, regions, and countries in this fund are not the product of top-down forecasts or opinions, but merely stem from our company-by-company search for compelling investment opportunities. Fixed Income Our security selection process begins with an assessment of credit risk. While we recognize that many managers would mention credit rating as an indication of credit risk, few, if any, managers formally and consistently evaluate current and projected ratings, expected rating volatility, and impartially assign value to the fixed income securities under review based on those assessments. Our approach addresses not only actual ratings and our own internal assessment thereof, but also adjusts the valuation for both our long-term rating expectation as well as the path of ratings over time. At the core, we simply try to buy bonds priced at a discount to our assessment of credit quality three to five years forward. However, such an approach alone would be too simplistic as it ignores any declines in credit quality which might be expected to occur in the interim, as well as the market reaction to such ratings volatility. In addition, it would fail to recognize analytical risk inherent in making our assessment. Economic conditions, industry factors, or other items might shift more than expected, resulting in a ratings path lower than we projected. Assume that a mid-to-high A-rated issuer has a quarter or two of weak earnings. The historical default probability for single A-rated issuers is very low; even if the weakness caused a one-notch downgrade, the historical default probability remains virtually zero. Why then, do bonds widen in this situation and why should one think of credit risk in terms of downgrade risk as well as default risk? At fairly high ratings, statistics do not suggest a significant increase in default probability upon downgrade, but as a company moves down the ratings scale, the increase in default probability has risen quickly with each downgrade. Thus, over larger rating moves, default risk and downgrade risk are closely tied; downgrades are a symptom of increased default risk. Valuing a security only on its long-term credit rating fails to value the real risk which would be assumed if the security's credit ratings changed during the interim. By incorporating both the long-term credit rating and interim downgrade risk into our decision, we are better able to adjust our valuation for the real risk assumed while helping to reduce the impact of other factors which can drive valuations:
Our investments are made with credit work being done up front, and we believe we are better prepared to evaluate downgrades and the resulting shifts in market valuation should they occur. In making the credit risk assessment, we frequently rely on Brandes' internal equity research group for financial statement information, company background, and an understanding of industry trends and developments. We also utilize rating agency analysis, third-party credit analysis, and our Fixed Income Group's own financial statement analysis. In order to address those issues, our credit risk assessment includes our assessment of current ratings, our expectation for ratings over time given our most probable scenario, and our expectation for ratings under a probable worst-case scenario. This worst-case scenario is not meant to reflect an absolute worst-case under any and all conditions, but rather is meant to be a duly conservative assessment of ratings given a reasonable amount of stress to our most probable scenario. These three rating assessments serve as the starting point for estimating intrinsic value and for setting buy and sell targets. We believe that a comprehensive, goal-oriented investment plan is a cornerstone of successful investing. Your financial advisor can work with you to develop, implement, and monitor your plan.
Mutual fund investing involves risk; principal loss is possible. Please refer to the Brandes Institutional International Equity Fund Prospectus, Institutional Global Equity Fund Prospectus, Separately Managed Account Reserve Trust - SMART Prospectus and the Institutional Core Plus Fixed Income Prospectus for important information about the investment company including investment objectives, risks, charges and expenses. To obtain a hard copy Prospectus, please call the Mutual Fund Group at 800.395.3807. The Brandes Funds are distributed by Quasar Distributors, LLC.
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