Joel Greenblatt Discusses the Thrill of Investing

Episode Summary

Executive Summary: The conversation centers on Joel Greenblatt’s investing philosophy and career: value investing as buying businesses below intrinsic value, the role of concentration and patience in outsized returns, and how Gotham evolved from a concentrated hedge fund to diversified, tax-efficient products like Gotham Index Plus. Greenblatt argues markets remain inefficient, active management can work if done differently, and investor behavior—not lack of opportunity—is the main obstacle.

Main Topics: Early investing lessons and formation of a value mindset (Priority: 5/5): Greenblatt recounts a formative dog-track betting mistake and his Wharton years, where Ben Graham’s writings convinced him that markets are not perfectly efficient and that value investing is about understanding what a business is worth and paying less. Why value investing is cyclical, not dead (Priority: 5/5): He rejects narrow factor definitions of value (low price-to-book or price-to-sales) and argues that true value investing focuses on business cash flows and intrinsic value. He says long stretches of underperformance reflect cycles or crowding, not the end of the approach. Gotham Capital’s concentrated, high-return years (Priority: 4/5): Greenblatt explains Gotham Capital’s 1985 launch, early backing from Michael Milken, and extraordinary returns driven by small size and concentrated portfolios. He emphasizes that high returns were aided by limited assets and by taking only a handful of best ideas. The shift to diversified, scalable long-short investing (Priority: 5/5): After returning outside capital and later relaunching, Gotham evolved into a broader research and tech-driven platform. Greenblatt describes buying cheap, good businesses and shorting expensive ones across hundreds of names to create scalable, lower-volatility returns. Gotham Index Plus and solving the active-management problem (Priority: 5/5): He describes a hybrid product built on top of the S&P 500: fully replicating the index, then overlaying long and short positions in favored and least-favored stocks. The design aims to preserve benchmark familiarity while adding protection and excess return. Investor behavior, patience, and the challenge of sticking with alpha (Priority: 4/5): Greenblatt argues that even strong active managers can underperform for years, causing clients to abandon them at the wrong time. He says the key is patience, long horizons, and recognizing that good valuation work may take years to be rewarded. Teaching, books, and practical lessons for investors (Priority: 3/5): The interview closes with Greenblatt discussing his books, mentors, and the importance of reading, discipline, and giving back. He frames investing as a learnable craft rooted in business analysis rather than market noise.

Key Arguments: True value investing means estimating a business’s intrinsic value and buying at a discount, not merely selecting low price-to-book or low price-to-sales stocks. Value investing is cyclical; periods of weak performance do not imply the strategy is broken because business fundamentals and market sentiment move in cycles. Stocks are ownership shares of businesses, so they should be evaluated like businesses, not treated as abstract price series optimized by portfolio formulas alone. Concentrated portfolios can produce extreme returns, but they also create big drawdowns; diversification can improve the consistency of outcomes when the underlying process is sound. The market can support active management, but clients often fail to endure the inevitable periods of underperformance required for alpha generation. Gotham Index Plus is designed to make active management easier to stick with by anchoring to the S&P 500 while adding a disciplined long-short overlay. In bad markets, cheap high-cash-flow businesses and shorts of expensive hope-stocks should provide strong relative performance and downside protection. Patience is one of the most important investment edges: if valuation work is correct, the market will eventually agree, though timing is unpredictable.

Data Points: Gotham Capital annual compound return: 50% before fees - Greenblatt says Gotham Capital compounded at 50% annually over its first 10 years (1985-1995). Gotham initial outside capital: About $7 million - He says Gotham started in 1985 with roughly $7 million, including money linked to Michael Milken. Portfolio concentration: 6 to 8 ideas made up 80%+ of the portfolio - He describes Gotham Capital as highly concentrated during its most successful period. Capital returned to investors: Half after 5 years; all after 10 years - He explains that outside capital was partially returned after five years and fully returned after ten years due to scale and strategy constraints. Years teaching at Columbia: 22 years - Greenblatt says he has taught value and special situations investing at Columbia for 22 years. Gotham Index Plus launch: Institutional fund in March 2009; mutual fund in 2012 - He dates the launch of the successor strategy and its later retail expansion. Active-management study period: 2000-2010 - He cites a decade-long study showing investors often failed to capture manager alpha due to poor timing. Best mutual fund return in the decade: Up 18% annually - During 2000-2010, the best mutual fund in the sample gained 18% per year while the market was flat. Average investor return in that fund: Lost 11% annually on a dollar-weighted basis - He uses this to show how investor behavior can destroy realized returns. Best institutional-manager record: 97% spent at least 3 of 10 years in the bottom half - This illustrates that top long-term managers often endure significant interim underperformance. Bottom-quartile exposure among winners: 79% spent at least 3 years in the bottom quartile - Used to argue that beating the market requires periods of poor-looking results. Bottom-decile exposure among winners: 47% spent at least 3 years in the bottom decile - Supports the point that even top managers can look terrible for extended stretches. Current S&P 500 valuation percentile: 16th percentile toward expensive - Greenblatt says the market is more expensive than it has been 84% of the time over the last 28 years. Expected 1-year forward returns: 3% to 5% - Based on historical valuation outcomes from the current level. Expected 2-year forward returns: 8% to 10% - Based on historical valuation outcomes from the current level. Index Plus overlay size: 90 cents long and 90 cents short - He explains the fund holds the S&P 500 and then overlays equal long and short active positions. Long-stock universe: Top 250 of the S&P 500 names by preference - He says the fund adds to the stocks it likes most within the S&P 500. Long-short spread behavior: Double-digit spreads in all four down-market test years - He says the strategy performed especially well in market downturns during backtests. Magic Formula backtest (small caps): About 30% annualized from 1988-2004 - He cites the performance of the cheap-and-good screen on smaller companies. Magic Formula backtest (Russell 1000): About 22% annualized versus about 12% for the market - He cites similar but more scalable results for large-cap stocks. Operating leverage example: $2 cost to rent for $62 resale margin - He uses the trade-show anecdote to explain how operating leverage can magnify gains and losses.

Pivotal Quotes: "stocks are actually ownership shares of businesses that you value and try to buy at a discount" — Joel Greenblatt: He uses this to define his core investing framework and distinguish it from factor-based or formulaic interpretations of value. "to beat the market, you have to do something different than the market" — Joel Greenblatt: He explains why active managers must diverge from benchmarks and therefore experience long stretches of underperformance. "if you do good valuation work, the market will agree with them. I just never tell them when" — Joel Greenblatt: His teaching advice on patience and valuation discipline: correctness matters, but timing is unknowable.

Implications: For investors, the message is to focus on business value, not market noise, and to expect cycles and interim pain. For managers, scalable alpha likely requires patience, disciplined process, and structures that help clients stay invested long enough to benefit.