A devastating year for nearly all investors, 2008 was especially nightmarish for AllianceBernstein. The New York–based money management firm saw its institutional AXA Bernstein Global Value Equity Fund — a flagship product in the value sphere, over which the firm once reigned supreme — plunge 50.6 percent and underperform 96 percent of its peers, according to eVestment Alliance, an investment tracking outfit headquartered in Atlanta. AllianceBernstein’s assets under management tumbled 42.3 percent, from $800.4 billion at the end of 2007 to $462 billion one year later, and its share price plummeted about 70 percent, from $63.87 to $19.07.
Thus it was that on the afternoon of Friday, December 19, 2008, the head of security for AllianceBernstein stepped into chairman and CEO Lewis Sanders’ spacious, 39th-floor office, with its spectacular vista of Central Park. He helped Sanders gather a few framed pictures and put them in a cardboard box, then escorted him into the elevator and accompanied him to the ground floor. The legendary value investor climbed into a waiting car, concluding a 40-year relationship that began in 1968 when he joined Sanford C. Bernstein & Co. as a junior analyst and continued through the firm’s merger with Alliance Capital Management in 2000.
The 63-year-old Sanders had been having discussions about retirement for a while with AXA Group, the French insurance conglomerate that controls AllianceBernstein, but that December he was bluntly informed that his departure had been scheduled for the 19th.
AllianceBernstein’s performance snapped back into full form the following year, vindicating Sanders’ judgment in picking distressed value stocks, says Sharon Fay, the firm’s chief investment officer for global value equities. But his unceremonious exit, which was witnessed by a senior executive, was hardly an auspicious prelude to his next career move: opening a value boutique. Nevertheless, he launched Sanders Capital last September, in a temporary Park Avenue office just a few blocks from AllianceBernstein’s headquarters. (This summer the firm moves across the street into swankier digs.)
Although Sanders is identified with traditional value investing, his new firm is anything but old-fashioned. He is using an innovative, all-asset approach that he refined during his last nine months at AllianceBernstein. The strategy applies to bonds as well as stocks, giving him the freedom to invest across the capital structure of a company that he identifies as a value play. At AllianceBernstein it was folded into a hedge fund, the All Asset Deep Value Fund, that was launched in June 2008. It shot up 20 percent by that December and outpaced the Standard & Poor’s 500 index by more than 42 percentage points in the fourth quarter. (Sanders devoted his last week at AllianceBernstein to shutting down the fund; the firm could not maintain it without him, owing to a key-man clause in the documentation that identified him as integral to its operation.)
Sanders, who is CEO and co-CIO of his new firm, employs a three-step approach to selecting investments for his All Asset Value Portfolio Series. First, he uses quantitative screens to sort through hundreds of stocks and single out dozens of companies whose share prices are depressed. Sanders believes it is always anxiety among investors that pushes down stock prices, so his second step is to deploy analysts to determine the cause of the anxiety — a product recall, for instance, or the prospect of litigation — and whether it is likely to be temporary or permanent.
“Value is behavioral, not financial,” he says. “The fundamental research problem is first to understand the nature of the anxiety.” If the anxiety is deemed to be only temporary, then the stock is a buy.
Finally, Sanders vets his picks through a quantitative analysis software program designed to weed out mistakes.
He applies the same process to picking bonds. “If the world gets anxious about some company’s stock, you can be sure they are anxious about its bonds.”
The challenge of being a value investor of any kind in today’s market is that conventional value stocks are in short supply. Nevertheless, Sanders’ research has led him, somewhat surprisingly, to large, stable companies such as information-technology providers Hewlett Packard Co. and IBM Corp., whose stock prices were pretty much the same last month as they were two years earlier, despite strong gains in earnings.
To hear Sanders tell it, investors are skeptical that IT manufacturers can keep their profits growing. “People are saying, ‘I don’t believe these margins are sustainable, they are so good.’ That’s the source of the anxiety, but the skepticism is ill-founded,” he says.
Palo Alto, California–based HP closed at $53.90 on April 23, just 49 cents more than its 2008 high of $53.41. IBM tells a similar story. Despite strong performance — the Armonk, New York–based company reported a 13 percent jump in first-quarter profit, compared with the same period last year — Big Blue closed at $129.99 on April 23, 1 cent less than its precrisis peak in 2008.
From a value perspective, Sanders says, these stocks are beneficiaries of neglect: Investors largely have been ignoring them during the current rally in favor of bank and other obviously distressed stocks. They won’t ignore them much longer. “As employment picks up, you will see an increase in spending on IT by corporations,” predicts John Mahedy, co-CIO and research director of Sanders Capital. “It’s a business recovery story.”
Other favorites — with Sanders Capital, if not with the market — include consumer nondurables, such as McDonald’s Corp. and PepsiCo. The Oak Brook, Illinois–based fast-food giant has been taking business away from more expensive restaurants, but as of late last month its stock price was only about 14 percent above its precrisis 2008 high of $62.22 in August. Purchase, New York–based PepsiCo’s stock price fell 18.9 percent from its 2008 high through April 23, 2010. “Because they are safe havens, they radically underperformed during the recovery,” says Sanders. “They have been left in the dust.”
They’re not likely to stay there, however. “It does not take long for people to grasp that a stable company with predictable cash flows can be inexpensive,” Sanders says.
Sanders also has his eye on natural-gas producers, such as Oklahoma City’s Chesapeake Energy Corp., which he says will benefit from breakthroughs in drilling technology that lets them tap hitherto unreachable natural gas in shale formations. Because this implies an eventual surge in supply, gas is trading at its lowest price in six months — less than $4.00 per million BTU. Suggesting that investors are worried about low gas prices, Chesapeake’s stock had fallen 64.1 percent from July 2008 through late April. But abundant cheap gas will spawn new demand from new sources, such as gas-powered truck fleets that circulate on planned routes with gas-equipped filling stations and gas-powered plants to recharge battery-operated cars, and Chesapeake is well-positioned to benefit, Sanders says.
“If people are convinced that oil will stay close to $100 a barrel, then they will start to make the investment in natural gas in two or three years,” Mahedy adds.
The firm also owns defense contractors such as General Dynamics Corp., Lockheed Martin Corp. and Raytheon Co., which trade for only about 11 times forecast 2010 earnings, compared with the market average of 14 to 15 times earnings. “People think there are a couple of hot wars in the Middle East that will eventually get resolved — that spending on defense is going to go down,” Sanders says. “I think it’s pretty obvious that we face a lot of threats, so the probability of a major cut in the defense budget is really small.”
This is the first opportunity Sanders has had to build his all-asset strategy into a full-fledged product. His portfolio of 42 stocks is loaded onto a different structure than that of the AllianceBernstein product, which was a limited partnership for qualified investors. The current incarnation has no deep-value stocks — the deeply distressed financial and other shares that fell the furthest in the crisis and recovered the fastest in the rally.
The strategy won’t have a deep-value bias until the next global market rout sends investors scurrying toward a new generation of distressed stocks, Sanders says. The most likely catalyst, in his estimation? China, whose frenetic growth is fueling a scramble for commodities; Sanders questions whether that demand is sustainable. At the moment, investors have no interest in companies without some exposure to China. To Sanders that lack of exposure is one way to identify stocks that are out of favor now but could present future value.
To get the firm started, Sanders invested hundreds of millions of dollars of his own money, got a few private clients to invest and pulled in assets from three AllianceBernstein clients: $3 billion from Vanguard Group, $200 million from the Oregon Investment Council and $25 million from the South Dakota Investment Council. (The latter two had invested in the All Asset Deep Value Fund.)
“Lew Sanders is one of the greatest investors, once you get past Warren Buffett, of anyone in the last 30 to 40 years,” says Matt Clark, investment officer for South Dakota’s $6 billion retirement system.
Sanders’ track record is indeed impressive. The Bernstein U.S. Value strategy beat the S&P 500 index by 3 percentage points a year, on average, for 36 years, from 1971 to 2007, reckons Bruce Greenwald, a professor at New York’s Columbia Business School who teaches a course on value investing. “In the world of quantitatively oriented value investors, he has to be one of the best two or three.”
Sanders plans to keep his firm small. “The last thing I want to do is build anything large and complicated,” he says. “AllianceBernstein was an asset gatherer, but Sanders Capital won’t be.” He won’t divulge his firm’s total assets under management, but a rough estimate would place the figure at close to $4 billion. The Vanguard assets are in a separate portfolio called Value Equities, which holds many of the same stocks as All Asset Value. The rest are in the All Asset Value Portfolio Series, which holds some securities — such as convertible preferred stock issued by Bank of America Corp., Chesapeake Energy and Wells Fargo & Co. — that Value Equities does not own.
A deep-value investor at heart, Sanders sees parallels today to what turned out to be a value-laden stock market 30 years ago — a déjà vu of fears of rising prices, interest rates and energy costs. But he plans to tread carefully. “What distinguishes value from a value illusion is whether the anxiety that is motivating the seller of a stock is transitory or permanent,” Sanders says. “If it’s permanent it’s a so-called value trap.” He is betting that copious research and 42 years of experience will keep him out of the trap.
