From the October 2008 issue of Research Magazine • Subscribe!

October 1, 2008

What Would Graham Say?

Who would've thought to package the value-oriented investment philosophy of the famed Benjamin Graham into an index based financial product?

Never short on ideas, Wall Street has invented just such a thing.

In August, Deutsche Bank launched the ELEMENTS exchange-traded notes (ETNs) linked to what they call, "Benjamin Graham Intelligent Value Indices."

We can only imagine what's next.

A Warren Buffett ETF or ETN?

Don't laugh. As you read, enterprising marketers are probably negotiating or attempting to negotiate with Buffett to license the rights to his name. If Wall Streeters can't make billions aping Buffett's investment prowess, the next best thing is to try making it big by selling financial products with his face on them. And it's not as far-fetched of an idea as you may think. Who would've thought Paul Newman's mug would appear on a salad dressing bottle?

The Deutsche Bank ETNs are the first to offer investors exposure to indexes based on the value-oriented investment philosophy of Benjamin Graham.

The new ETNs will be listed on the NYSE Arca, as follows:o Benjamin Graham Large Cap Value ELEMENTS (BVL)o Benjamin Graham Small Cap Value ELEMENTS (BSC)o Benjamin Graham Total Market Value ELEMENTS (BVT)

Value investing is an investment strategy that aims to identify undervalued stocks. It was popularized by Graham in his book called Security Analysis, published in 1934 with David Dodd. (See "The Investment Classics" on p.68.)

Graham was a Columbia University professor and economist. Graham's work influenced an entire generation of investors, including the heralded Warren Buffett.

The wrath of the financial markets so far in 2008 has spared no one, including more than a few noted value investors. (See the latest abysmal performance of Legg Mason's Bill Miller or Oakmark's Bill Nygren as proof.)

Interestingly, many of them are performing much worse than major benchmarks like the S&P 500 (SPY) and Dow Industrials (DIA) that have no value bias. Have Wall Street's money managers eliminated Graham's "margin of safety" with their nonsensical stock picks?

Graham reasoned the best time to invest in a company is when its market price is trading below its intrinsic value. He also argued that investors shouldn't be overly concerned with the fluctuations of stock prices because in the short term the stock market is like a voting machine but during the long run it's like a weighing machine.

"Doesn't his [Graham's] admonition to 'strictly adhere to standard, conservative, and even unimaginative forms of investment' eerily echo the concept of market indexing?," asked John Bogle in his latest work, The Little Book of Common Sense Investing (Wiley, 2007). Bogle points out that toward the end of his life Graham acknowledged the difficulty in achieving market-beating returns even with a strict value discipline.

In a 1976 interview Graham said, "I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. In the old days, any well trained security analyst could do a good job of selecting undervalued issues through detailed studies; but in light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost." Later that same year, Graham died.

Bogle concludes: "With Benjamin Graham's long perspective, common sense, hard realism, and wise intellect, there is no doubt whatsoever in my mind that he would have applauded the index fund."

If Graham were alive today, which index funds would he endorse? While no one can know for sure, it's hard to see him endorsing expensive gimmicky index funds. And what about bank notes linked to indexes bearing his name? Would he be proud or embarrassed?

Whether the Deutsche Bank ETNs will live up to Graham's exalted name remains to be seen.

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Ron DeLegge is the San Diego-based editor of www.etfguide.com.

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