Value Investing and Austrian Economics: A Merge that Yields Compound Interest

October 19, 2018

The 2018 Mont Pelerin Society General Meeting, ‘Discovery, Competition and the Pursuit of Happiness’, was held in Gran Canaria, the largest of the Canary Islands. This year members and guests were treated to a number of speeches by Spanish fund manager Francísco García Paramés. Known as the ‘Warren Buffet of Spain’, Paramés offered his unique perspective of merging value investing with Austrian economics and detailed key elements of his investing philosophy.

Defining value investing simply as “investing (that) aims to invest sensibly over the long term, estimating companies’ capacity to generate future earnings and paying a competitive price for them”, Paramés’ guiding principle is to invest all savings not required for the immediate future exclusively in equities. Paramés maintained that equities not only offer the best returns but are also the least risky asset in the long term. Paramés explained that investors confuse short-term volatility with risk, which is the potential of permanent loss of capital. It is short-term volatility that enables the value investor to purchase equities in quality and established businesses at a discount. While financial assets such as government bonds which are generally perceived as less risky than equities and in finance theory are used to establish the “risk-free rate”, actually carry great risk due to their susceptibility to monetary intervention. During a period of inflation due to an increase in the money supply from central banks, the future repayment of bonds will be in a currency that is devalued. However, equities will adjust for inflation and maintain their purchasing power against other goods and services. Paramés also bypasses mainstream neo-classical economics in favour of Austrian economics.

While Austrian economics has been marginalised in mainstream academia relative to neo-classical economics, Paramés elaborated on the value in understanding the economy from an Austrian perspective. Austrian economics places the individual and ‘human action’ at the centre of the economy. It is this axiom along with theories developed by the Austrian school such as the Austrian Business Cycle theory that offers investors the most accurate perception of economic reality. Paramés explained that adopting an Austrian perspective enables investors to both capitalise on market opportunities and avoid the consequences of government interventions.

Paramés closed one of his speeches with the optimistic observation that in the future there will be more opportunity than ever for the Austrian-value investor. A contemporary trend in finance has been the continued rise of passive index investing. However, Paramés points out that if everyone was to become a passive index investor, price discovery and capital allocation would not exist. Thus as this trend continues more equities will be mispriced and opportunities presented to the astute value investor.

Attendance of the Mont Pelerin Society is one of many incredible opportunities on offer to students from the Mannkal Economic Education Foundation to explore the philosophy of liberty and free market economics. I am truly thankful to Ron Manners and the team at Mannkal for yet another opportunity to deepen my own knowledge.

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Bayley was our 2016 EOY Scholar to the Lion Rock Institute in Hong Kong. Bayley is currently studying a Bachelor of Commerce at UWA, majoring in Finance. He is also interning at the Mannkal office.