Over the last few years many of my clients at Cannon Asset Managers, and other interested followers of our research, have become familiar with the results of the now 13-year-old study into the merits of value investing in South Africa. There is good reason for this: over this period our hypothetical deep-value or dog portfolio has delivered a return of 1 038 percent, which is almost five-times the market return over the same period.

This year’s report, titled Diamonds and Dogs: The Year the Dog Ate My Homework, represents the fifth edition of the study. The title stems from the fact that 2008 was an awful year for investment returns – one in which colourful stories about why the goods have not been delivered abound, much like Monday morning in the classroom. Given that the past year brought with it massive capital destruction, it is instructive to consider the results produced. Our deep value portfolio, or what we prefer to call our dog portfolio, returned negative 31.6 percent. This is modestly ahead of the negative 34.3 percent produced by the growth portfolio, or so-called diamond portfolio. Both of these ‘active’ portfolios produced results that were well below the market, which itself produced an awful negative 19.5 percent over the year.

Notwithstanding the tough year that the dog portfolio had, our deep-value portfolio, has beaten the market in nine years during the 13-year survey. The dog portfolio also has beaten the diamond portfolio, which is constructed using growth investing principles, on all but one occasion in the past 13 years. The cumulative result is that, since the start of 1996, Cannon Asset Manager’s dog portfolio has gathered up a return of 1 038 percent, compared to the diamond portfolio’s 189 percent and the market’s 227 percent. The figure below captures the net results of the different portfolios.

Source: Cannon Asset Managers

Apart from the aspect of investment returns, Diamonds and Dogs: The Year the Dog Ate My Homework, emphasises a number of other points that stand out from our 13-year experience.

Investment management is not a short-term activity. Successful investment results are produced over years and decades. During this time, bouts of underperformance will be experienced which will test the mettle of even the most hardened veteran (2008 is testimony to this point). However, conviction, discipline and dedication to the value strategy will produce the ultimate reward of superior investment results. Investors tend to be highly sensitive to company news, economic events and market movements. As a consequence, many investors are hyper-active in the management of their portfolios and myopic in measuring investment performance by emphasising near-term portfolio results. These investors lose sight of the woods for the trees by abandoning successful strategies, or chopping and changing portfolio managers or portfolio management styles. The implication for their investment returns seldom is positive.

The success of any deep-value approach is found in its contrarian nature. Put simply, the more a portfolio looks like the market the more an investor will get market-like results. The only way to beat the market is to be different to the market. This means that often a contrarian portfolio will lag or lead the market – sometimes by wide margins. Many investors find this stance impossible to hold – and instead will scurry for the safety of a closet tracker or, somewhat more honestly, a tracker portfolio. Again, however, the only way you can hope to beat the market is by being different to the market.

Successful active portfolio management is not derived from furious trading activity, but rather from placing emphasis on owning attractively-priced assets in sufficient weights for long enough periods that value is recognised by the market. To this end, it is worth noting that our dog portfolio is restructured once a year.

Further, the extent to which our investment process hunts for deep value is indicated by the price-earnings ratio of our 2009 dog portfolio of 5.2 times and its dividend yield of an equal 5.2 percent. This compares to the diamond portfolio’s price-earnings ratio of 15.6 times and dividend yield of 3.4 percent. By contrast, the market trades on a trailing price-earnings ratio of 9.8 times and a dividend yield of 4.2 percent.

The results of our study show that in order to produce exceptional results, investors do not need to take unnecessary risk.

The above points can probably be distilled to a single argument: successful investing is simple, but not easy. I hope you find the report as interesting to read as I have found enjoyable to put together.

The full report is attached by clicking on the following link: Diamonds and Dogs: The Year the Dog Ate My Homework and the appendices are available by clicking on the following link Diamonds and Dogs: Appendices.