Market Inefficiency, Liquidity Flywheels, Property Shape Arbitrage, Together With Hong Kong Land
July 28, 2020
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Conventional economical theory holds that the marketplace inwards fiscal assets ought to live 'efficient'. Large numbers of intelligent together with diligent investors receive got access to largely the same puddle of information, together with are highly motivated to origin out together with exploit whatever underpricings that exist. It is believed this competitive procedure volition inevitably drive assets to their fair value - i.e. those that accurately reverberate their chance together with payoff characteristics, and also toll assets correctly relative to i another.
If exclusively the Blue Planet were so simple. While this theory is seductive inwards its simplicity, it is also incorrect inwards its simplicity. While much has been written nigh the purpose fear, greed, together with diverse cognitive biases play inwards mispricings (also important), often overlooked or underestimated is the purpose structural institutional marketplace position factors play, which encapsulate traditional economical ideas of agency conflicts together with data asymmetry. What is picayune understood - together with I promise to debate inwards this article - is that marketplace position inefficiency is structural and behavioural, rather than informational, which is why I believe it volition ever exist, together with supply ample chance for the well-heeled.
The efficient marketplace position hypothesis (EMH) misses i real of import signal - the bulk of security/asset-level investment decisions are non made yesteryear the ultimate owners of capital, but instead via their appointed intermediaries - whether they live traditional active asset managers, or passive vehicles (which mechanically purchase stocks inwards proportion to their index representation). The EMH implicitly assumes terminate investors are making straight purchases of private securities; are fully informed nigh the idiosyncratic chance together with payoff characteristics of those private securities; together with are investing with fourth dimension horizons that accord with the underlying duration of the cash flows of the assets they purchase.
However, inwards reality, most ultimate owners of uppercase are non making straight purchases of securities; are less than perfectly informed nigh the chance together with payoff characteristics of the underlying assets inwards the portfolio (only the realised returns together with volatility outcomes from month-to-month); together with are often investing with fourth dimension horizons considerably shorter than the duration of the underlying assets - peculiarly for stocks (where durations average 50 years, compared to the typical fourth dimension horizon of most investors, which is mayhap 3-5 years at most).
Ultimate owners of capital, or their direct appointed representatives (advisors or asset allocators), are at to the lowest degree one-step removed from grass roots private safety selection. Instead, they are to a greater extent than concerned with higher-level asset resources allotment decisions, which are influenced yesteryear perceptions of risk, reward, growth potential, together with volatility associated with aggregated asset classes, which may live radically disconnected from the actual risk/reward characteristics of the private securities comprising these larger clusters. They also often react procyclically to realised render together with volatility outcomes, exiting assets classes that receive got exhibited misfortunate returns and/or high volatility, together with increasing allocations to assets that receive got performed good - peculiarly with limited downside volatility.
This has important consequences for the way assets are priced, together with at a organization level, tin resultant inwards really massive levels of marketplace position inefficiency,* together with this inefficiency tin also live highly persistent, because the arbitrage forces that are supposed to right mispricings are non exclusively relatively ineffective inwards the curt term, but oftentimes overwhelmed yesteryear structural flows-based feedback loops that receive got a style to amplify rather than moderate these inefficiencies.
More pointedly, markets receive got a structural style towards the emergence of what I trace equally 'liquidity flywheels', which inwards my sentiment is the largest together with most under-appreciated contributor to marketplace position inefficiency ('liquidity' hither is defined equally 'liquid capital' that is available to live invested into diverse fiscal or existent assets). Liquidity flywheels are discussed inwards the department straightaway below. Later, I beak over how the distortionary affect of institutional asset resources allotment practices tin Pb to the same underlying assets being valued at real unlike levels with real unlike costs of capital, together with usage Hong Kong Land equally an example.
Liquidity flywheels
What is a liquidity flywheel? A liquidity flywheel is a province of affairs where inflows into an asset cast Pb to buying force per unit of measurement area that pushes upwards prices, leading to favourable apparent render together with volatility characteristics inwards the said asset class. This favourable outcome together with so attracts yet to a greater extent than inflows, leading to yet to a greater extent than buying, etc. Conversely, poorly performing asset classes with important downside volatility tin Pb to investor redemptions, leading to forced selling that contributes to yet farther toll declines, yielding fifty-fifty worse returns together with fifty-fifty greater redemptions, together with so on. This procedure tin move on for years, together with sometimes fifty-fifty for decades, together with is a telephone commutation contributor - mayhap the most of import contributor - to both major asset-class bubbles, equally good equally asset toll busts together with secular lows that Pb to burn downward sales prices (which are 'anti-bubbles' driven yesteryear the same drivers of bubbles inwards reverse). The disconnect betwixt the ultimate possessor of funds together with the at-the-coal-face investors really engaged inwards private safety analysis is telephone commutation to this process, because terminate investors receive got picayune to move on other than realised investment returns together with volatility, together with it introduces both data asymmetries together with agency conflicts that tin drive radical marketplace position inefficiency.
An 'asset class' hither tin relate to a broad category such equally 'venture capital' or 'equities', or (more commonly for equities), diverse classes of equities divided yesteryear geography, marketplace position cap range, style, sector, or factor. Industries or countries enjoying and/or expected to relish rapid growth, which are perceived equally offering important opportunities, are the frequent locus of inward liquidity flywheels, equally people crowd into a theme to teach 'exposure' to growth opportunities, together with the toll increases such flows engender receive got a style to live seen equally validating the narrative, which acts to trigger yet to a greater extent than inflows.
A perfect instance of a liquidity flywheel is what happened with WeWork, which saw its valuation teach bid upwards to an astonishing meridian of US$47bn, fifty-fifty though the companionship was ultimately worthless, with picayune to demonstrate for years of operating losses other than the accumulation of billions of dollars of long term lease liabilities. It occurred because a seductive growth together with new-economy disruption narrative, spearheaded yesteryear Masayoshi Son, resulted inwards the Vision Fund together with other Venture Capital funds attracting large inflows, together with the rush to set those funds to move drove the valuations of companies similar WeWork sharply higher. That resulted inwards higher mark-to-market returns inwards the said VC funds, which Pb to greater investor demand to pour coin into VC funds to cash inwards on the boom. This Pb to yet to a greater extent than coin pushing valuations fifty-fifty higher.
The procedure also industrial plant inwards opposite for asset classes that teach cheaper together with cheaper over time. In theoretical EMH academic models, investors receive got access to unlimited capital, together with if they spot a mispricing, they volition purchase undervalued assets, borrowing uppercase when needed frictionlessly at the 'risk gratis rate' to facilitate this process. However, inwards the existent world, investors' buying together with selling conduct is constrained yesteryear the amount of uppercase they receive got at their disposal - both with abide by to having also picayune cash, and too much - together with their capacity to borrow is also constrained. Indeed, investors that borrow inwards size to purchase inexpensive stocks are apt to live margined out together with forced to liquidate their holdings - peculiarly because margin requirements are often increased yesteryear brokers equally prices fall.
A fund managing director mightiness receive got a huge number of real inexpensive stocks they would dear to buy, but if they do non receive got whatever available cash, they do non teach to 'vote' on the marketplace position toll yesteryear buying inwards the opened upwards market, equally they lack the liquidity to do so - inwards the curt term at to the lowest degree (longer term, yous tin reinvest dividends). Furthermore, if the said managing director is suffering investor redemptions due to recent returns beingness poor, together with so regardless of the underlying managers' views on the long term attractiveness of private securities, they volition live forced to sell. It is thence non uncommon for those most informed nigh the opportunities inwards undervalued securities to live really selling them rather than buying, inwards straight contradiction to the EMH.
The opposite is also truthful for fund managers receiving large inflows - they must purchase regardless of their personal views on the valuation appeal of stocks inside their purview. It is perfectly possible they believe the stocks to live overvalued together with yet soundless purchase them inwards size, because they receive got to. Many fund managers are explicitly constrained inwards how much cash they tin concur yesteryear their fund charter, but fifty-fifty for those managers that are non so explicitly constrained, if the said managing director elects to concur a large amount of cash hoping for a amend chance to buy, together with markets move on to rise, they chance potentially catastrophic levels of underperformance, together with so is a luxury they tin ill-afford.
If the said managing director runs a technology scientific discipline fund, their clients allocated them coin because from an asset resources allotment standpoint, they decided they wanted exposure to the technology scientific discipline sector. If 6 months afterward the tech sector is upwards 50% together with this private fund is exclusively upwards 10% because they are asset cash waiting for a amend opportunity, the terminate clients are non going to live real happy, together with inwards all likelihood volition inquire for their coin back, so they tin give it to a better-performing tech fund managing director who is upwards 60%. As a result, institutions volition also tend to purchase regardless of price, together with at the real to the lowest degree concur large index weight stocks inwards proportion to their index representation, to avoid the chance of underperforming.
What is notable nigh this procedure is how picayune all this buying together with selling, together with all the pronounced volatility inwards asset prices inwards drives (including major secular bull together with conduct markets), has anything at all to do with rational 'price discovery' inwards the traditional EMH sense. It explains why markets tin live populated yesteryear highly intelligent, informed, together with hardworking people, and also live grossly inefficient together with absurdly volatile. Liquidity flywheels tin move on for many many years, together with are a frequent crusade of long periods of underperformance for value managers, because it is the effect of liquidity flywheels that crusade stocks to move undervalued inwards the kickoff place, together with at that topographic point is no argue to appear a liquidity flywheel to all of a precipitous opposite just because for sure stocks receive got already move cheap.
Much has been said nigh the dreadful performance of value over the yesteryear decade, together with inwards item the final few years, together with patch at that topographic point are many causes for this (a theme for some other spider web log post), what is most missing from the dialogue is a recognition of the fact that this is non unusual, together with long stretches of value underperformance receive got happened many times before, together with for largely the same reasons. It happened inwards the 1990s tech bubble, together with it also happened inwards the 1960-early 1970s 'Nifty 50' bubble equally well. Including the most recent tech/growth bubble, that is nigh i time every twenty years. The major crusade inwards all these cases was a liquidity flywheel that Pb to for sure parts of the marketplace position becoming extremely overpriced, due to a decade of procyclical inflows that drove multiples to the stratosphere.
The telephone commutation number is that the ultimate owners of capital, or their immediate representatives (advisors together with asset allocators), often brand their asset resources allotment decisions on the footing of backward-looking render together with volatility realisations, equally without straight knowledge of the underlying securities, that is all they receive got to move on. And the of import affair is that this procedure is inherently self-sustaining, non self-correcting, such that inefficiencies tend to teach larger over time, non smaller (until an inflection signal is reached, next which real dramatic reversals tin happen), together with the powerfulness of investors to arbitrage these inefficiencies is largely absent.
Liquidity flywheels are i of the most of import forces inwards markets, together with i of the most under-appreciated. They are also the telephone commutation argue why momentum strategies work (until they don't) - something that the EMH also declared to live impossible, together with yet which quantitative analysis of yesteryear marketplace position activity clearly refutes. So long equally at that topographic point are liquidity flywheels inwards markets, momentum volition live a strategy that works, provided one has a reliable agency yesteryear which to determine when momentum has turned, because when momentum reversals happen, they move on large together with fast.
Different prices together with costs of uppercase for the same asset
Another of import outcome of these institutional forces is that radically unlike costs of uppercase (and hence asset valuations) tin emerge for the very same assets, depending on how they are packaged, together with the differences are often non trivial. If the EMH held, the same assets should live priced inwards the same way, regardless of how they are packaged (they are, after all, the same assets), but inwards the existent world, nosotros often come across real considerable departure emerge, together with those differences tin often move years, or fifty-fifty decades, without beingness arbitraged away.
Consider for instance a stock similar Hong Kong Land (HKL SP). HKL has a marketplace position capitalisation of nigh US$9bn, together with yet holds nigh US$37bn of existent estate at its most lately appraised marketplace position value (end of calendar 2019). A meaningful proportion of HKL's existent estate is super prime number component subdivision buildings inwards Singapore together with HK, such equally the Marina Bay Financial Center inwards Singapore, together with Exchange Square inwards Hong Kong. These are amongst the most desirable prime number locations inwards HK together with Singapore, together with equally a resultant almost ever relish approximately 100% occupancy together with favourable ongoing rent revisions. The companionship has exclusively real modest levels of debt (US$3bn), so high leverage is non the crusade of the disconnect, together with this modest story of debt is offset yesteryear the value of diverse evolution projects they hold, which are of a slightly larger magnitude to the company's debt burden. Assuming the latter 2 net, the stock is thence trading at nigh 25c inwards the dollar of its unleveraged real estate holdings.
Now to live sure, it is possible that recent events - non just covid-19, but recent political developments inwards HK - receive got increased the chance of long term value erosion, should HK for e.g. lose its station equally a desirable offshore fiscal center. However, this real large gap betwixt HKL's stock marketplace position valuation, together with the private marketplace position valuation of its assets, has persisted for a long time, together with good earlier these recent developments. The stock is downward some 50% from its 2017 highs, but fifty-fifty at its recent peaks, the stock was soundless trading at 50c inwards the dollar of the opened upwards marketplace position value of its prime number existent estate assets.
So why are the same assets attracting 2-3x crease differences inwards prices? It has a lot to do simply with the way the assets are packaged from an asset cast standpoint, together with the unlike costs of uppercase that apply to unlike investor constituencies together with asset classes. HKL's super-prime existent estate assets are valued on the books (and inwards the existent world) at cap rates equally depression equally 3% (and often closer to 2% cyberspace of costs together with tax). In a Blue Planet with null involvement rates, this is non an unrealistically depression yield for super-prime assets with favourable trends inwards rent revisions, A-grade tenants, long lease terms, together with an income current that is inflation protected. Even a modest stride of 2% annual rental growth (below historical averages) would generate all-in after-tax returns of some 4%, which with inflation protection, is real attractive relative to bonds together with other high-grade debt.
However, the number is that active equity managers - who are the natural buyers of HKL stock - are non benchmarked against cash together with high-grade bond returns, or fifty-fifty high-grade existent estate. HKL, equally a listed company, is component subdivision of the "listed equities" bucket (and to a greater extent than specifically, the "Asia ex-Japan listed equities" bucket), together with the performance of the institutions that purchase HKL are thence benchmarked against equity marketplace position indices, rather than cash or bonds. The average stock inwards Singapore together with HK is currently priced (in my estimation) with an expected render of mayhap 10%, which is some other way of maxim the cost of (listed) equity inwards these regions is currently nigh 10%. If equity managers were to purchase HKL together with realise exclusively a 4% render (which they probable would if the stock was priced at 1x book), but the index was to generate 10% pa, it would live of picayune do goodness to the fund managing director to debate to their clients that the returns are depression chance together with quite attractive relative to fixed income. The clients would say, nosotros allocated yous coin to teach "equities exposure", together with you're exclusively upwards 4% together with the marketplace position is upwards 10%, together with that is non satisfactory performance. Because HKL is component subdivision of the "listed equities" bucket, it is expected to deliver "listed equities" returns of 10%.
Consequently, listed on populace markets, the assets that underlie HKL are priced with a cost of uppercase reflective of Singaporean together with HK equities inwards general, which is a cost of uppercase that bears no relation to the cost of uppercase private buyers of prime number A-grade existent estate are land of study to. Because HKL's underlying assets generate exclusively mayhap 4%, this requires the stock merchandise at nigh i 3rd of volume value (ignoring recent declines which are covid/HK related). Another way to cry back nigh this would live to imagine a companionship that owned exclusively 30-yr treasuries yielding (say) 3%. If the stock traded at 0.3x book, it would offering a render of 10% instead of 3%. The underlying assets together with cash flow current are the same, but the costs of uppercase are unlike (here, 3% for long bonds, 10% for equities).
The cost of uppercase for listed equities is higher because equities are volatile, together with in general, the cash flows of businesses (averaged across all types) are much less dependable than those of existent estate. The work is that from a fundamental/operational perspective, stocks are non "more risky" yesteryear definition, because it real much depends on what type of assets the companionship holds. Individual companies tin attain from the most speculative, risky biotech startups or resources exploration company, to holders of some of the lowest risk, most dependable cash-generating assets inwards the Blue Planet (A-grade existent estate, franchised incumbent businesses with huge moats together with steady cash flow streams). In this respect, the real thought that "stocks" inwards full general are an "asset class" is deeply flawed - they are an aggregation of private businesses with hugely variant chance profiles. However, inwards the Blue Planet of industrial scale asset allocation, stock-level differences are typically lost inwards translation when large scale asset resources allotment decisions are made betwixt 'listed equities', 'fixed income', 'alternatives', 'developed marketplace position equity vs. emerging marketplace position equity', etc, together with and so results are assessed against an overall equity benchmark.
The ultimate effect of this is that the cost of uppercase that is applied to assets tin come upwards to reverberate less the idiosyncratic nature of the underlying assets, together with to a greater extent than simply the asset cast packaging. Put long bonds or high-grade existent estate into a companionship together with and so listing that companionship on the stock market, together with all of a precipitous the same underlying bonds or existent estate are transformed into a "listed equity", together with because a higher "listed equity" cost of uppercase is together with so applied to those assets, the entity volition merchandise at a steep discount. Change the packaging, together with all of a precipitous yous come across the same assets merchandise at radically unlike prices.
Repackaging listed existent estate into a REIT vehicle (Real Estate Investment Trust) tin sometimes pair this gap. There are funds that tin invest inwards REITs together with benchmark their returns to the overall performance of REITs, and/or other yield-based strategies/assets ('yield alternatives'). This tin lower the cost of uppercase yesteryear changing the benchmark for comparing from stocks inwards general, to fixed income or a specific cast of yield stocks. It is for this argue that companies similar HKL volition sometimes spin off existent estate holdings into REITs to 'unlock value'. In an efficient market, at that topographic point ought to live no such chance to 'unlock value', but inwards the existent Blue Planet where institutional realities tin create large differences inwards the cost of uppercase for the same assets, the chance is real real.
But let's move further. Let's suppose HKL's yield assets were instead packaged into an unlisted/illiquid "alternatives" asset cast manufactured yesteryear a private equity sponsor, which marketed the vehicle equally a low-risk yield production that aimed to generate a superior yield to those available on bonds/fixed income. The assets could also live leveraged upwards to juice returns together with increment the manufactured yield from 2-4% unlevered to mayhap 4-6% levered. The 4-6% yield could together with so live marketed to institutional investors together with asset allocators looking for replacements for their miserly bond yields. When the footing for comparing becomes long bonds at 1%, rather than equity benchmarks, all of a precipitous 4% looks good. The result? A 4% cost of uppercase is used instead of 10%, together with the same assets are valued at radically unlike prices, depending on the packaging.
The argue this alchemy tin move is that at that topographic point is an institutionalised aversion to volatility. Volatility is non just uncomfortable, but it is a career/reputation chance to whoever decided to brand such an asset resources allotment determination - i.e. a fiscal advisor, or asset allocator with fiduciary responsibilities. If somebody puts uppercase into HKL stock together with the stock falls 20%, that looks bad. It looks similar a 20% loss, fifty-fifty if the underlying assets are soundless generating the same cash flows equally before, together with the dividend yield of the stock has simply risen. This is where the duration mismatch number rears its caput - if i buys together with holds HKL for 50 years, temporary portion toll volatility won't brand a shred of long term departure - inwards fact portion toll declines volition live positive, equally dividends tin live reinvested at a higher yield. However, inwards reality, the duration of the career interests of advisors together with asset allocators is much shorter than that - they are concerned with how returns fare over the the adjacent few quarters together with years, how that looks to clients, together with how that is probable to influence their compensation.
Consequently, the minimization of volatility/drawdown chance is highly prized, together with yesteryear keeping the assets 'private', these "alternative" vehicles tin supply investors with the comfortable together with expedient illusion of a lack of volatility. HKL's stock price, for instance, has fallen some 50% inwards the yesteryear three years, equally the marketplace position has repriced its assets from an expected render of mayhap 6% to 10%. The company's dividend has remained stable, with the stock's yield increasing from 3% to 6%. By keeping the assets private, however, yous tin study the underlying cash flow returns of 2-4% (leveraged upwards to 4-6%), together with claim that the value of your assets has non changed. After all, the private marketplace position value of the assets has non fallen (it has non for HKL either). The terminate results is an attractive yield for clients of 4-5%, without having to conduct the chance of explicit volatility/drawdowns.
The wish to avoid looking bad yesteryear suffering such a drawdown is what is driving a huge moving ridge of coin into private equity together with other "alternative" vehicles, which are often just a repackaging of assets yous tin purchase on stock markets, with higher leverage together with much higher valuations, but with the powerfulness to spare clients of the appearance of volatility/drawdowns. The cost of uppercase with this newfangled packaging is structurally lower because returns are non benchmarked against listed equities, but instead cash together with bond yields, together with other depression chance yield alternatives. Because involvement rates together with bond yields are so low, 4% returns appear quite attractive (vs. say 1%). Investors are happy. They allocate to a greater extent than capital, because 4% beats their 1% cost of capital. Again, it is of import to emphasise that these are exactly the same assets, just with unlike packaging, together with the packaging tin alter the cost of uppercase dramatically. This is a real clear refutation of the EMH.
There are some arbitrage forces inwards markets that tin assist right these differences, but they are highly imperfect. If HKL were smart, for instance, they would accept payoff of the large arbitrage chance that exists betwixt the private together with populace marketplace position costs of uppercase yesteryear selling some of their existent estate assets together with using the proceeds to purchase dorsum stock. Activist investors together with corporate take-outs tin play a role, but inwards HKL's case, it already has a controlling shareholder (Jardine Matheson), which forecloses the chance for activism.
Conclusion
It is of import to empathize that marketplace position inefficiency is structural together with behavioural, non informational. Many investors endeavour to invest on the footing that marketplace position inefficiency is informational inwards nature, together with dedicate tremendous amount of fourth dimension together with resources to trying to come upwards up with amend data than the adjacent guy. However, inwards today's markets, the primary source of inefficiency is structural/agency driven, together with the way to exploit that is non to teach amend information, but to receive got a construction that allows i to engage inwards long term value arbitrage that other investors cannot (often taking the cast of buying underlying assets that are really depression risk, but are priced equally if they were real high chance because they are component subdivision of an asset cast that is to a greater extent than often than non perceived to live high risk). This requires a broad together with unconstrained mandate (by geography, asset class, etc), long term capital, a rigorously long term approach, together with an extreme tolerance for volatility together with benchmark variation, which requires patience together with emotional fortitude that is sorely lacking inwards today's instant gratification world.
Outperforming inwards the long term is really non real difficult, but it requires highly lumpy results, often marked yesteryear long periods of lackluster returns, punctuated yesteryear curt periods of spectacular results, which move on amongst liquidity flywheel/momentum reversals, which are inflection points that do non move on real often. Furthermore, usually, the worse value is performing, the closer i is to the terminate of a liquidity flywheel bubble bicycle (value had a woeful fourth dimension inwards 1999, for instance), because value is the 'anti-bubble' aspect - a Newtonian equal together with opposite reaction - of liquidity flywheels driving bubbles elsewhere inwards markets. It is redemption flywheels that drive value opportunities, together with redemption flywheels are often the resultant of investors pulling coin out of unpopular areas of the marketplace position inwards a rush to teach exposure to hot areas of markets.
Taking payoff of long term opportunities is extremely hard for investors with the incorrect construction together with incorrect investors, however, equally massive redemptions volition probable move on right when opportunities are most ripe, together with non all funds volition live able to live on the inevitable lean periods. Value funds unopen downward en volume inwards 1999, for instance, together with the same affair has been happening of late. Lean cost structures together with - ideally - large principal FUM participation from the fund managers is a must.
Outperforming inwards the curt term with consistency, yesteryear contrast, is extremely hard. The best way to do it is commonly a momentum strategy, which industrial plant most of the time, but occasionally yields disastrous results on precipitous momentum reversals. Momentum is the polar opposite of value - it generates proficient returns most of the time, together with disastrous returns a minority of the time.
The latter strategy is a to a greater extent than remunerative strategy for fund managers, however, fifty-fifty if it often leaves long term investors worse off, which is why it is to a greater extent than popular/common. While the proficient times roll, large performance fees are banked, together with it is investors that are left with the losses when it all turns to custard. This is why value investing remains relatively uncommon, despite its long rails tape of success, together with inwards my sentiment a combination of agency conflicts, data asymmetry, volatility-phobia, together with the wish for quick results, volition all but ensure marketplace position inefficiencies continue, together with considerable opportunities for long term value investors volition stay for many generations to come.
LT3000
Disclosure: I do non ain shares inwards HKL
*In my perception, a lot of investors confuse rising prices with increased marketplace position efficiency. Prices becoming to a greater extent than expensive, inwards general, has null to do with efficiency, fifty-fifty though it does receive got the practical effect of making value opportunities harder to come upwards by. People also confuse the fact that value doesn't move inwards the curt term - often for many years - with marketplace position efficiency. It is non the efficiency that makes it hard to outperform inwards the curt term, but the inefficiency - prices are driven yesteryear flows, non fundamentals, often for many years, together with so fifty-fifty real diligent together with accurate valuation move tin often non live rewarded yesteryear markets for years, leading to an erroneous perception of marketplace position efficiency.
Postscript: Just equally this annotation was going to press, I noticed that HSKE-listed Dongfeng Motor (489 HK) - a companionship I blogged nigh inwards 2018 here - was trading upwards equally much equally 30% equally the companionship announced it was planning an A-share listing on the frothy ChiNext exchange. A broker study noted (in an understated comment to say the least): "ChiNext-listed stocks are trading at high valuations (57x trailing 12-month PE average equally of 27 July...), which should boost the valuation of Dongfeng's H-shares (trading at 2.8x FY20E PE)."
I cannot cry back of a amend demonstration of many of the points raised inwards this article - unlike costs of uppercase for the same assets inwards unlike markets, together with the effect of long term liquidity flywheel cycles. Positive liquidity flywheels receive got driven A-share valuations to extremes of 50-100x P/Es, together with negative liquidity flywheel cycles receive got driven for sure H-shares to equally depression equally 2-3x. Dongfeng together with H-shares to a greater extent than often than non (excepting the tech sector) are at nowadays xiii years into a liquidity flywheel downcycle, which started inwards 2007. Since my spider web log post, Dongfeng has continued to shipping service strong operational results, earnings growth, together with increased dividends. The stock has fallen from HK$9 to HK$5.
If exclusively the Blue Planet were so simple. While this theory is seductive inwards its simplicity, it is also incorrect inwards its simplicity. While much has been written nigh the purpose fear, greed, together with diverse cognitive biases play inwards mispricings (also important), often overlooked or underestimated is the purpose structural institutional marketplace position factors play, which encapsulate traditional economical ideas of agency conflicts together with data asymmetry. What is picayune understood - together with I promise to debate inwards this article - is that marketplace position inefficiency is structural and behavioural, rather than informational, which is why I believe it volition ever exist, together with supply ample chance for the well-heeled.
The efficient marketplace position hypothesis (EMH) misses i real of import signal - the bulk of security/asset-level investment decisions are non made yesteryear the ultimate owners of capital, but instead via their appointed intermediaries - whether they live traditional active asset managers, or passive vehicles (which mechanically purchase stocks inwards proportion to their index representation). The EMH implicitly assumes terminate investors are making straight purchases of private securities; are fully informed nigh the idiosyncratic chance together with payoff characteristics of those private securities; together with are investing with fourth dimension horizons that accord with the underlying duration of the cash flows of the assets they purchase.
However, inwards reality, most ultimate owners of uppercase are non making straight purchases of securities; are less than perfectly informed nigh the chance together with payoff characteristics of the underlying assets inwards the portfolio (only the realised returns together with volatility outcomes from month-to-month); together with are often investing with fourth dimension horizons considerably shorter than the duration of the underlying assets - peculiarly for stocks (where durations average 50 years, compared to the typical fourth dimension horizon of most investors, which is mayhap 3-5 years at most).
Ultimate owners of capital, or their direct appointed representatives (advisors or asset allocators), are at to the lowest degree one-step removed from grass roots private safety selection. Instead, they are to a greater extent than concerned with higher-level asset resources allotment decisions, which are influenced yesteryear perceptions of risk, reward, growth potential, together with volatility associated with aggregated asset classes, which may live radically disconnected from the actual risk/reward characteristics of the private securities comprising these larger clusters. They also often react procyclically to realised render together with volatility outcomes, exiting assets classes that receive got exhibited misfortunate returns and/or high volatility, together with increasing allocations to assets that receive got performed good - peculiarly with limited downside volatility.
This has important consequences for the way assets are priced, together with at a organization level, tin resultant inwards really massive levels of marketplace position inefficiency,* together with this inefficiency tin also live highly persistent, because the arbitrage forces that are supposed to right mispricings are non exclusively relatively ineffective inwards the curt term, but oftentimes overwhelmed yesteryear structural flows-based feedback loops that receive got a style to amplify rather than moderate these inefficiencies.
More pointedly, markets receive got a structural style towards the emergence of what I trace equally 'liquidity flywheels', which inwards my sentiment is the largest together with most under-appreciated contributor to marketplace position inefficiency ('liquidity' hither is defined equally 'liquid capital' that is available to live invested into diverse fiscal or existent assets). Liquidity flywheels are discussed inwards the department straightaway below. Later, I beak over how the distortionary affect of institutional asset resources allotment practices tin Pb to the same underlying assets being valued at real unlike levels with real unlike costs of capital, together with usage Hong Kong Land equally an example.
Liquidity flywheels
What is a liquidity flywheel? A liquidity flywheel is a province of affairs where inflows into an asset cast Pb to buying force per unit of measurement area that pushes upwards prices, leading to favourable apparent render together with volatility characteristics inwards the said asset class. This favourable outcome together with so attracts yet to a greater extent than inflows, leading to yet to a greater extent than buying, etc. Conversely, poorly performing asset classes with important downside volatility tin Pb to investor redemptions, leading to forced selling that contributes to yet farther toll declines, yielding fifty-fifty worse returns together with fifty-fifty greater redemptions, together with so on. This procedure tin move on for years, together with sometimes fifty-fifty for decades, together with is a telephone commutation contributor - mayhap the most of import contributor - to both major asset-class bubbles, equally good equally asset toll busts together with secular lows that Pb to burn downward sales prices (which are 'anti-bubbles' driven yesteryear the same drivers of bubbles inwards reverse). The disconnect betwixt the ultimate possessor of funds together with the at-the-coal-face investors really engaged inwards private safety analysis is telephone commutation to this process, because terminate investors receive got picayune to move on other than realised investment returns together with volatility, together with it introduces both data asymmetries together with agency conflicts that tin drive radical marketplace position inefficiency.
An 'asset class' hither tin relate to a broad category such equally 'venture capital' or 'equities', or (more commonly for equities), diverse classes of equities divided yesteryear geography, marketplace position cap range, style, sector, or factor. Industries or countries enjoying and/or expected to relish rapid growth, which are perceived equally offering important opportunities, are the frequent locus of inward liquidity flywheels, equally people crowd into a theme to teach 'exposure' to growth opportunities, together with the toll increases such flows engender receive got a style to live seen equally validating the narrative, which acts to trigger yet to a greater extent than inflows.
A perfect instance of a liquidity flywheel is what happened with WeWork, which saw its valuation teach bid upwards to an astonishing meridian of US$47bn, fifty-fifty though the companionship was ultimately worthless, with picayune to demonstrate for years of operating losses other than the accumulation of billions of dollars of long term lease liabilities. It occurred because a seductive growth together with new-economy disruption narrative, spearheaded yesteryear Masayoshi Son, resulted inwards the Vision Fund together with other Venture Capital funds attracting large inflows, together with the rush to set those funds to move drove the valuations of companies similar WeWork sharply higher. That resulted inwards higher mark-to-market returns inwards the said VC funds, which Pb to greater investor demand to pour coin into VC funds to cash inwards on the boom. This Pb to yet to a greater extent than coin pushing valuations fifty-fifty higher.
The procedure also industrial plant inwards opposite for asset classes that teach cheaper together with cheaper over time. In theoretical EMH academic models, investors receive got access to unlimited capital, together with if they spot a mispricing, they volition purchase undervalued assets, borrowing uppercase when needed frictionlessly at the 'risk gratis rate' to facilitate this process. However, inwards the existent world, investors' buying together with selling conduct is constrained yesteryear the amount of uppercase they receive got at their disposal - both with abide by to having also picayune cash, and too much - together with their capacity to borrow is also constrained. Indeed, investors that borrow inwards size to purchase inexpensive stocks are apt to live margined out together with forced to liquidate their holdings - peculiarly because margin requirements are often increased yesteryear brokers equally prices fall.
A fund managing director mightiness receive got a huge number of real inexpensive stocks they would dear to buy, but if they do non receive got whatever available cash, they do non teach to 'vote' on the marketplace position toll yesteryear buying inwards the opened upwards market, equally they lack the liquidity to do so - inwards the curt term at to the lowest degree (longer term, yous tin reinvest dividends). Furthermore, if the said managing director is suffering investor redemptions due to recent returns beingness poor, together with so regardless of the underlying managers' views on the long term attractiveness of private securities, they volition live forced to sell. It is thence non uncommon for those most informed nigh the opportunities inwards undervalued securities to live really selling them rather than buying, inwards straight contradiction to the EMH.
The opposite is also truthful for fund managers receiving large inflows - they must purchase regardless of their personal views on the valuation appeal of stocks inside their purview. It is perfectly possible they believe the stocks to live overvalued together with yet soundless purchase them inwards size, because they receive got to. Many fund managers are explicitly constrained inwards how much cash they tin concur yesteryear their fund charter, but fifty-fifty for those managers that are non so explicitly constrained, if the said managing director elects to concur a large amount of cash hoping for a amend chance to buy, together with markets move on to rise, they chance potentially catastrophic levels of underperformance, together with so is a luxury they tin ill-afford.
If the said managing director runs a technology scientific discipline fund, their clients allocated them coin because from an asset resources allotment standpoint, they decided they wanted exposure to the technology scientific discipline sector. If 6 months afterward the tech sector is upwards 50% together with this private fund is exclusively upwards 10% because they are asset cash waiting for a amend opportunity, the terminate clients are non going to live real happy, together with inwards all likelihood volition inquire for their coin back, so they tin give it to a better-performing tech fund managing director who is upwards 60%. As a result, institutions volition also tend to purchase regardless of price, together with at the real to the lowest degree concur large index weight stocks inwards proportion to their index representation, to avoid the chance of underperforming.
What is notable nigh this procedure is how picayune all this buying together with selling, together with all the pronounced volatility inwards asset prices inwards drives (including major secular bull together with conduct markets), has anything at all to do with rational 'price discovery' inwards the traditional EMH sense. It explains why markets tin live populated yesteryear highly intelligent, informed, together with hardworking people, and also live grossly inefficient together with absurdly volatile. Liquidity flywheels tin move on for many many years, together with are a frequent crusade of long periods of underperformance for value managers, because it is the effect of liquidity flywheels that crusade stocks to move undervalued inwards the kickoff place, together with at that topographic point is no argue to appear a liquidity flywheel to all of a precipitous opposite just because for sure stocks receive got already move cheap.
Much has been said nigh the dreadful performance of value over the yesteryear decade, together with inwards item the final few years, together with patch at that topographic point are many causes for this (a theme for some other spider web log post), what is most missing from the dialogue is a recognition of the fact that this is non unusual, together with long stretches of value underperformance receive got happened many times before, together with for largely the same reasons. It happened inwards the 1990s tech bubble, together with it also happened inwards the 1960-early 1970s 'Nifty 50' bubble equally well. Including the most recent tech/growth bubble, that is nigh i time every twenty years. The major crusade inwards all these cases was a liquidity flywheel that Pb to for sure parts of the marketplace position becoming extremely overpriced, due to a decade of procyclical inflows that drove multiples to the stratosphere.
The telephone commutation number is that the ultimate owners of capital, or their immediate representatives (advisors together with asset allocators), often brand their asset resources allotment decisions on the footing of backward-looking render together with volatility realisations, equally without straight knowledge of the underlying securities, that is all they receive got to move on. And the of import affair is that this procedure is inherently self-sustaining, non self-correcting, such that inefficiencies tend to teach larger over time, non smaller (until an inflection signal is reached, next which real dramatic reversals tin happen), together with the powerfulness of investors to arbitrage these inefficiencies is largely absent.
Liquidity flywheels are i of the most of import forces inwards markets, together with i of the most under-appreciated. They are also the telephone commutation argue why momentum strategies work (until they don't) - something that the EMH also declared to live impossible, together with yet which quantitative analysis of yesteryear marketplace position activity clearly refutes. So long equally at that topographic point are liquidity flywheels inwards markets, momentum volition live a strategy that works, provided one has a reliable agency yesteryear which to determine when momentum has turned, because when momentum reversals happen, they move on large together with fast.
Different prices together with costs of uppercase for the same asset
Another of import outcome of these institutional forces is that radically unlike costs of uppercase (and hence asset valuations) tin emerge for the very same assets, depending on how they are packaged, together with the differences are often non trivial. If the EMH held, the same assets should live priced inwards the same way, regardless of how they are packaged (they are, after all, the same assets), but inwards the existent world, nosotros often come across real considerable departure emerge, together with those differences tin often move years, or fifty-fifty decades, without beingness arbitraged away.
Consider for instance a stock similar Hong Kong Land (HKL SP). HKL has a marketplace position capitalisation of nigh US$9bn, together with yet holds nigh US$37bn of existent estate at its most lately appraised marketplace position value (end of calendar 2019). A meaningful proportion of HKL's existent estate is super prime number component subdivision buildings inwards Singapore together with HK, such equally the Marina Bay Financial Center inwards Singapore, together with Exchange Square inwards Hong Kong. These are amongst the most desirable prime number locations inwards HK together with Singapore, together with equally a resultant almost ever relish approximately 100% occupancy together with favourable ongoing rent revisions. The companionship has exclusively real modest levels of debt (US$3bn), so high leverage is non the crusade of the disconnect, together with this modest story of debt is offset yesteryear the value of diverse evolution projects they hold, which are of a slightly larger magnitude to the company's debt burden. Assuming the latter 2 net, the stock is thence trading at nigh 25c inwards the dollar of its unleveraged real estate holdings.
Now to live sure, it is possible that recent events - non just covid-19, but recent political developments inwards HK - receive got increased the chance of long term value erosion, should HK for e.g. lose its station equally a desirable offshore fiscal center. However, this real large gap betwixt HKL's stock marketplace position valuation, together with the private marketplace position valuation of its assets, has persisted for a long time, together with good earlier these recent developments. The stock is downward some 50% from its 2017 highs, but fifty-fifty at its recent peaks, the stock was soundless trading at 50c inwards the dollar of the opened upwards marketplace position value of its prime number existent estate assets.
So why are the same assets attracting 2-3x crease differences inwards prices? It has a lot to do simply with the way the assets are packaged from an asset cast standpoint, together with the unlike costs of uppercase that apply to unlike investor constituencies together with asset classes. HKL's super-prime existent estate assets are valued on the books (and inwards the existent world) at cap rates equally depression equally 3% (and often closer to 2% cyberspace of costs together with tax). In a Blue Planet with null involvement rates, this is non an unrealistically depression yield for super-prime assets with favourable trends inwards rent revisions, A-grade tenants, long lease terms, together with an income current that is inflation protected. Even a modest stride of 2% annual rental growth (below historical averages) would generate all-in after-tax returns of some 4%, which with inflation protection, is real attractive relative to bonds together with other high-grade debt.
However, the number is that active equity managers - who are the natural buyers of HKL stock - are non benchmarked against cash together with high-grade bond returns, or fifty-fifty high-grade existent estate. HKL, equally a listed company, is component subdivision of the "listed equities" bucket (and to a greater extent than specifically, the "Asia ex-Japan listed equities" bucket), together with the performance of the institutions that purchase HKL are thence benchmarked against equity marketplace position indices, rather than cash or bonds. The average stock inwards Singapore together with HK is currently priced (in my estimation) with an expected render of mayhap 10%, which is some other way of maxim the cost of (listed) equity inwards these regions is currently nigh 10%. If equity managers were to purchase HKL together with realise exclusively a 4% render (which they probable would if the stock was priced at 1x book), but the index was to generate 10% pa, it would live of picayune do goodness to the fund managing director to debate to their clients that the returns are depression chance together with quite attractive relative to fixed income. The clients would say, nosotros allocated yous coin to teach "equities exposure", together with you're exclusively upwards 4% together with the marketplace position is upwards 10%, together with that is non satisfactory performance. Because HKL is component subdivision of the "listed equities" bucket, it is expected to deliver "listed equities" returns of 10%.
Consequently, listed on populace markets, the assets that underlie HKL are priced with a cost of uppercase reflective of Singaporean together with HK equities inwards general, which is a cost of uppercase that bears no relation to the cost of uppercase private buyers of prime number A-grade existent estate are land of study to. Because HKL's underlying assets generate exclusively mayhap 4%, this requires the stock merchandise at nigh i 3rd of volume value (ignoring recent declines which are covid/HK related). Another way to cry back nigh this would live to imagine a companionship that owned exclusively 30-yr treasuries yielding (say) 3%. If the stock traded at 0.3x book, it would offering a render of 10% instead of 3%. The underlying assets together with cash flow current are the same, but the costs of uppercase are unlike (here, 3% for long bonds, 10% for equities).
The cost of uppercase for listed equities is higher because equities are volatile, together with in general, the cash flows of businesses (averaged across all types) are much less dependable than those of existent estate. The work is that from a fundamental/operational perspective, stocks are non "more risky" yesteryear definition, because it real much depends on what type of assets the companionship holds. Individual companies tin attain from the most speculative, risky biotech startups or resources exploration company, to holders of some of the lowest risk, most dependable cash-generating assets inwards the Blue Planet (A-grade existent estate, franchised incumbent businesses with huge moats together with steady cash flow streams). In this respect, the real thought that "stocks" inwards full general are an "asset class" is deeply flawed - they are an aggregation of private businesses with hugely variant chance profiles. However, inwards the Blue Planet of industrial scale asset allocation, stock-level differences are typically lost inwards translation when large scale asset resources allotment decisions are made betwixt 'listed equities', 'fixed income', 'alternatives', 'developed marketplace position equity vs. emerging marketplace position equity', etc, together with and so results are assessed against an overall equity benchmark.
The ultimate effect of this is that the cost of uppercase that is applied to assets tin come upwards to reverberate less the idiosyncratic nature of the underlying assets, together with to a greater extent than simply the asset cast packaging. Put long bonds or high-grade existent estate into a companionship together with and so listing that companionship on the stock market, together with all of a precipitous the same underlying bonds or existent estate are transformed into a "listed equity", together with because a higher "listed equity" cost of uppercase is together with so applied to those assets, the entity volition merchandise at a steep discount. Change the packaging, together with all of a precipitous yous come across the same assets merchandise at radically unlike prices.
Repackaging listed existent estate into a REIT vehicle (Real Estate Investment Trust) tin sometimes pair this gap. There are funds that tin invest inwards REITs together with benchmark their returns to the overall performance of REITs, and/or other yield-based strategies/assets ('yield alternatives'). This tin lower the cost of uppercase yesteryear changing the benchmark for comparing from stocks inwards general, to fixed income or a specific cast of yield stocks. It is for this argue that companies similar HKL volition sometimes spin off existent estate holdings into REITs to 'unlock value'. In an efficient market, at that topographic point ought to live no such chance to 'unlock value', but inwards the existent Blue Planet where institutional realities tin create large differences inwards the cost of uppercase for the same assets, the chance is real real.
But let's move further. Let's suppose HKL's yield assets were instead packaged into an unlisted/illiquid "alternatives" asset cast manufactured yesteryear a private equity sponsor, which marketed the vehicle equally a low-risk yield production that aimed to generate a superior yield to those available on bonds/fixed income. The assets could also live leveraged upwards to juice returns together with increment the manufactured yield from 2-4% unlevered to mayhap 4-6% levered. The 4-6% yield could together with so live marketed to institutional investors together with asset allocators looking for replacements for their miserly bond yields. When the footing for comparing becomes long bonds at 1%, rather than equity benchmarks, all of a precipitous 4% looks good. The result? A 4% cost of uppercase is used instead of 10%, together with the same assets are valued at radically unlike prices, depending on the packaging.
The argue this alchemy tin move is that at that topographic point is an institutionalised aversion to volatility. Volatility is non just uncomfortable, but it is a career/reputation chance to whoever decided to brand such an asset resources allotment determination - i.e. a fiscal advisor, or asset allocator with fiduciary responsibilities. If somebody puts uppercase into HKL stock together with the stock falls 20%, that looks bad. It looks similar a 20% loss, fifty-fifty if the underlying assets are soundless generating the same cash flows equally before, together with the dividend yield of the stock has simply risen. This is where the duration mismatch number rears its caput - if i buys together with holds HKL for 50 years, temporary portion toll volatility won't brand a shred of long term departure - inwards fact portion toll declines volition live positive, equally dividends tin live reinvested at a higher yield. However, inwards reality, the duration of the career interests of advisors together with asset allocators is much shorter than that - they are concerned with how returns fare over the the adjacent few quarters together with years, how that looks to clients, together with how that is probable to influence their compensation.
Consequently, the minimization of volatility/drawdown chance is highly prized, together with yesteryear keeping the assets 'private', these "alternative" vehicles tin supply investors with the comfortable together with expedient illusion of a lack of volatility. HKL's stock price, for instance, has fallen some 50% inwards the yesteryear three years, equally the marketplace position has repriced its assets from an expected render of mayhap 6% to 10%. The company's dividend has remained stable, with the stock's yield increasing from 3% to 6%. By keeping the assets private, however, yous tin study the underlying cash flow returns of 2-4% (leveraged upwards to 4-6%), together with claim that the value of your assets has non changed. After all, the private marketplace position value of the assets has non fallen (it has non for HKL either). The terminate results is an attractive yield for clients of 4-5%, without having to conduct the chance of explicit volatility/drawdowns.
The wish to avoid looking bad yesteryear suffering such a drawdown is what is driving a huge moving ridge of coin into private equity together with other "alternative" vehicles, which are often just a repackaging of assets yous tin purchase on stock markets, with higher leverage together with much higher valuations, but with the powerfulness to spare clients of the appearance of volatility/drawdowns. The cost of uppercase with this newfangled packaging is structurally lower because returns are non benchmarked against listed equities, but instead cash together with bond yields, together with other depression chance yield alternatives. Because involvement rates together with bond yields are so low, 4% returns appear quite attractive (vs. say 1%). Investors are happy. They allocate to a greater extent than capital, because 4% beats their 1% cost of capital. Again, it is of import to emphasise that these are exactly the same assets, just with unlike packaging, together with the packaging tin alter the cost of uppercase dramatically. This is a real clear refutation of the EMH.
There are some arbitrage forces inwards markets that tin assist right these differences, but they are highly imperfect. If HKL were smart, for instance, they would accept payoff of the large arbitrage chance that exists betwixt the private together with populace marketplace position costs of uppercase yesteryear selling some of their existent estate assets together with using the proceeds to purchase dorsum stock. Activist investors together with corporate take-outs tin play a role, but inwards HKL's case, it already has a controlling shareholder (Jardine Matheson), which forecloses the chance for activism.
Conclusion
It is of import to empathize that marketplace position inefficiency is structural together with behavioural, non informational. Many investors endeavour to invest on the footing that marketplace position inefficiency is informational inwards nature, together with dedicate tremendous amount of fourth dimension together with resources to trying to come upwards up with amend data than the adjacent guy. However, inwards today's markets, the primary source of inefficiency is structural/agency driven, together with the way to exploit that is non to teach amend information, but to receive got a construction that allows i to engage inwards long term value arbitrage that other investors cannot (often taking the cast of buying underlying assets that are really depression risk, but are priced equally if they were real high chance because they are component subdivision of an asset cast that is to a greater extent than often than non perceived to live high risk). This requires a broad together with unconstrained mandate (by geography, asset class, etc), long term capital, a rigorously long term approach, together with an extreme tolerance for volatility together with benchmark variation, which requires patience together with emotional fortitude that is sorely lacking inwards today's instant gratification world.
Outperforming inwards the long term is really non real difficult, but it requires highly lumpy results, often marked yesteryear long periods of lackluster returns, punctuated yesteryear curt periods of spectacular results, which move on amongst liquidity flywheel/momentum reversals, which are inflection points that do non move on real often. Furthermore, usually, the worse value is performing, the closer i is to the terminate of a liquidity flywheel bubble bicycle (value had a woeful fourth dimension inwards 1999, for instance), because value is the 'anti-bubble' aspect - a Newtonian equal together with opposite reaction - of liquidity flywheels driving bubbles elsewhere inwards markets. It is redemption flywheels that drive value opportunities, together with redemption flywheels are often the resultant of investors pulling coin out of unpopular areas of the marketplace position inwards a rush to teach exposure to hot areas of markets.
Taking payoff of long term opportunities is extremely hard for investors with the incorrect construction together with incorrect investors, however, equally massive redemptions volition probable move on right when opportunities are most ripe, together with non all funds volition live able to live on the inevitable lean periods. Value funds unopen downward en volume inwards 1999, for instance, together with the same affair has been happening of late. Lean cost structures together with - ideally - large principal FUM participation from the fund managers is a must.
Outperforming inwards the curt term with consistency, yesteryear contrast, is extremely hard. The best way to do it is commonly a momentum strategy, which industrial plant most of the time, but occasionally yields disastrous results on precipitous momentum reversals. Momentum is the polar opposite of value - it generates proficient returns most of the time, together with disastrous returns a minority of the time.
The latter strategy is a to a greater extent than remunerative strategy for fund managers, however, fifty-fifty if it often leaves long term investors worse off, which is why it is to a greater extent than popular/common. While the proficient times roll, large performance fees are banked, together with it is investors that are left with the losses when it all turns to custard. This is why value investing remains relatively uncommon, despite its long rails tape of success, together with inwards my sentiment a combination of agency conflicts, data asymmetry, volatility-phobia, together with the wish for quick results, volition all but ensure marketplace position inefficiencies continue, together with considerable opportunities for long term value investors volition stay for many generations to come.
LT3000
Disclosure: I do non ain shares inwards HKL
*In my perception, a lot of investors confuse rising prices with increased marketplace position efficiency. Prices becoming to a greater extent than expensive, inwards general, has null to do with efficiency, fifty-fifty though it does receive got the practical effect of making value opportunities harder to come upwards by. People also confuse the fact that value doesn't move inwards the curt term - often for many years - with marketplace position efficiency. It is non the efficiency that makes it hard to outperform inwards the curt term, but the inefficiency - prices are driven yesteryear flows, non fundamentals, often for many years, together with so fifty-fifty real diligent together with accurate valuation move tin often non live rewarded yesteryear markets for years, leading to an erroneous perception of marketplace position efficiency.
Postscript: Just equally this annotation was going to press, I noticed that HSKE-listed Dongfeng Motor (489 HK) - a companionship I blogged nigh inwards 2018 here - was trading upwards equally much equally 30% equally the companionship announced it was planning an A-share listing on the frothy ChiNext exchange. A broker study noted (in an understated comment to say the least): "ChiNext-listed stocks are trading at high valuations (57x trailing 12-month PE average equally of 27 July...), which should boost the valuation of Dongfeng's H-shares (trading at 2.8x FY20E PE)."
I cannot cry back of a amend demonstration of many of the points raised inwards this article - unlike costs of uppercase for the same assets inwards unlike markets, together with the effect of long term liquidity flywheel cycles. Positive liquidity flywheels receive got driven A-share valuations to extremes of 50-100x P/Es, together with negative liquidity flywheel cycles receive got driven for sure H-shares to equally depression equally 2-3x. Dongfeng together with H-shares to a greater extent than often than non (excepting the tech sector) are at nowadays xiii years into a liquidity flywheel downcycle, which started inwards 2007. Since my spider web log post, Dongfeng has continued to shipping service strong operational results, earnings growth, together with increased dividends. The stock has fallen from HK$9 to HK$5.