Tag: Asset Management
This MINUTE could last you a lifetime: An investment thesis for a period of secular economic instability
We are living in times where a confluence of several secular and cyclical factors are resulting in a profitable rise of capital requirements for, and allocation in, the Materials, Industrials, Non-cyclicals, Utilities, Technology, and Energy (MINUTE) sectors.
“Well we know where we’re goin’ but we don’t know where we’ve been.
And we know what we’re knowing’ but we can’t say what we’ve seen.
And we’re not little children and we know what we want.
And the future is certain give us time to work it out.
We’re on a road to nowhere come on inside.
Takin’ that ride to nowhere we’ll take that ride…”
- Road to Nowhere by Talking Heads
The inexorable quest for “more”…of everything:
It is safe to assume, everyday, almost all of approximately 6.9 billion people wake up wanting more than they already have. Some aspire for more luxuries; others seek more necessities; a vast under-class, just struggles for more dignities.
Global commerce is an agile, pragmatic force transforming more and more lives than ever before. Thanks to the forces of globalization, we are witnessing a free-er flow of goods, services, capital, and people around the world. Also, largely thanks to globalization, every year tens of millions of people from a wide variety of emerging and frontier markets are joining the growing global mainstream of what broadly constitutes as “middle-class consumers.” This somewhat loose grouping of “middle income” consumers already constitutes roughly half of the world’s population.
More food is needed, produced and eaten. More clothes are bought, sold and worn. More property is being built and inhabited. More cars and trucks are being manufactured and driven. More oil, gas, coal and other conventional energy sources are being harnessed, distributed and consumed. More alternative energy sources are being discovered, produced and commercialized. Trillions of dollars of roads, railways, power plants, transmission networks, dams and bridges are being built and utilized. More paper is being used…and forests felled. More minerals are being mined, processed and used in a wider variety of industrial and consumer applications. More manufacturing is being done and absorbed – on a net global production basis.
It is an insatiable, inexorable quest for more…and more…and more from a planet that has its very real physical limits.
Resources are limited.
Demand is rising. Supply is not. In fact, supply is diminishing for a wide variety of natural resources.
It is that simple.
The real, the tangible, the substantial: The World is Pyramidal
Imagine Maslow’s hierarchy of needs represented in a world that isn’t round, ovular, or even flat.
The world is a four-dimensional pyramid of time, population, demand, and supply.
Due to the enormous pressure on resources owing to a rising global population and various other sub-plots, our times are characterized by exceptional change or instability underpinned by the triumvirate of: uncertainty, ambiguity, and complexity.
What is also undeniable is: because of – or in spite of – globalization, the individual or family is much more disconnected from a social support structure. During earlier times in more settled communities, this support structure was taken for granted. With professional certitude and financial stability petering out, the individual or family is much more vulnerable to the financial consequences of the high-velocity change we experience today and can anticipate to experience for the foreseeable future.
By mixing in the notion of rising demand and declining supply of natural resources, the concoction we have is a period that harkens back to our pre-historic ancestors’ times of operating in a hostile, uncertain, ambiguous, high-risk, constantly-evolving environment.
It is only natural that a Darwinian “survivalist” instinct kicks in among us to seek safe havens.
Investors are us: You and I.
Quite obviously, our investment decisions are not disconnected from the complex interaction of our personal, social, economic, and financial imperatives and choices.
Therefore, what we find is a seamless connective tissue between our psychological makeup which may be in “survivalist” mode and our investment bias to seek a real, tangible protection from the real, intangible economic storm. It is this quest for the real, the substantial that has Gold breaching record highs on a regular basis. Silver is at a 30-year high precisely for the same reason. In a period of secular uncertainty and instability, Gold can be expected to continue to hold its status as the ultimate haven of safety and trust. A haven that has stood the test of time for its ability to act as a reliable medium of exchange and as a store of value (or wealth). Gold has also, unsurprisingly, held its purchasing power over several thousand years of human commercial history. It has, and continues to be: rare, valuable, and tangible.
Due to demand-supply constraints, prices for most commodities are on a secular upwards trajectory anyway. What, however, we are witnessing is something much deeper and more primordial. We have begun to witness a global, long-term, broad, social, “survivalist” quest (beyond just the investment world) for the physical security of the real, the tangible and the substantial.
This survivalist quest is a pragmatic quest.
Manifestation of individual and societal “tail” risks; particularly of the “fat” variety:
The quest for financial security and a steady income at the expense of higher-risk, dividend income (or capital appreciation) is the underlying driver for fixed income security markets booming in most parts of the world.
Baby-boomers in many ageing, developed economies of the West have had multiple setbacks in regards to their retirement savings and entitlements over the last decade. At the start of the millennium came the dot-com bust, shortly followed by the 9/11 attacks and the collapse of financial markets with a deep, ensuing recession. Barely recovering from that shock, the Credit Crisis came bringing along with it the worst recession since the Great Depression.
As a result, a significant number of boomers have seen their nest eggs shrink just at the time when they have been made redundant or have had to accept lower paying positions with fewer benefits.
Hence, the need of (and pursuit for) income security, reliability, and predictability is only going to strengthen in the coming years.
Leading up to the Global Financial Crisis, trillions of dollars worth of “intangible” securities had disastrously evaporated into thin air. During the ensuing global “Credit Crunch,” we were all rudely awakened to the notion of “tail risks,” i.e. Risks that lie outside the confidence interval of the expected range of outcomes on a normal distribution curve. Nicholas Taleb’s “black swans” do exist. In its aftermath, The Great Recession has also illustrated how our inappropriate or inadequate intervention (e.g. not intervening to save Lehman) of regular tail risks can allow them to morph into “fat tail” risks – unleashing a set of devastating, systemic, and inter-connected outcomes in what has come to be called The Great Recession.
Even if “fat tail” risks do not actualize (or not as severely or frequently as in the recent past), our time is still to be characterized by an acute awareness of the possibility of tail risks in general, and “fat tail” risks in particular. Whether at the micro-economic (individual and family) level or at the macro-economic level, the notion of tail risks can be expected to play a significant role in the economic lives of nations, going forward.
A future flush with capital: Sovereign Indebtedness & Fiat Currency Debasement
Post-Global Financial Crisis, whether due to genuine commitment towards the welfare of their constituents or due to political expediency or some combination thereof, governments (particularly developed economies) have demonstrated a renewed sense of purpose to generate employment by investing in “energy security” and “infrastructure upgrade” projects for their respective economies. These investments are expected to be made through various fiscal measures such as:
a) shifting budgetary priorities away from defense, space and entitlements to sectors like energy and infrastructure projects,
b) launching deficit spending measures to invest in new infrastructure projects, and
c) raising taxes as well as growing the tax base, among other measures.
The ironic upshot of the Global Financial Crisis is to add more fuel to the fire that created all the havoc and instability in the first place. Further loosening of monetary policy and expansion of sovereign credit have been used as levers to stimulate economies out of the “credit crunch” that resulted from a crisis of confidence in the financial markets — which to begin with — was induced due to lax and expansionary monetary conditions sustained over an extended period of time. Since the Great Recession began, central banks across most of the developed, and several of the consequential emerging markets, have progressively eased interest rates to near zero. In fact, the prospect (and reality) of additional rounds of quantitative easing by central banks has been another favored recipe to further increase money supply in the global financial system.
Quantitative easing (or sovereign debt and other fixed income asset purchases by central banks through new fiat currency issuance) can continue for some time before inflationary pressures start to seep in to the real economy. As these sovereign credit purchases by central banks expands their balance sheets, ever larger proportions of their respective treasuries’ revenues have to go towards servicing this debt. As the costs of servicing this debt grows, the central bank has to print more money. It becomes a vicious circle.
In essence, all that such quantitative easing measures are doing is to leave sovereign treasuries more indebted, fiat currencies more debased, and asset prices inflated (primarily in nominal terms).
Asset price inflation is, however, very real for the ordinary citizen on Main Street. The component of asset price inflation that is over and above nominal levels owes its increases to rising demand for these assets by a growing number of consumers around the world. Further, one can argue that the “real rate” of inflation, based on fundamental demand-supply dynamics, is also magnified by market speculators betting on directional moves on asset prices thanks to the cheap money available within the financial system. As cheap money floods in from the financial economy to the real economy, the increasingly “financialized” world has begun to show ominous signs of expansive, unintended consequences being unleashed upon the broader society. The Global Financial Crisis, that began to show its first material consequences on the world economy in 2007 (and most will argue is still underway), can be expected to be only the first of many global “events” that will send shock-waves across the global economy for years to come before some sort of global “reset” will have to occur when the collective pain of the debtor nations and corporations gets too unbearable to prolong any further.
Private sector credit creation: A growth imperative for banks in a de-leveraging environment
Meanwhile, proprietary trading is on the way out for the money center banks and investment banks. Therefore, fee-based investment and corporate banking will become ever more consequential for generating profits for these institutions. This reduction and eventual evaporation of trading revenues will entail an aggressive pursuit for increasing lending and underwriting activities among the banks. We are entering a period where, on the one hand, there is a concentration of capital in the financial economy among the hands of relatively few banks. On the other hand, there is diffusion in the real economy where innovation happens and jobs are created. Hence, despite the enormous monetary stimulus programs rolled out by governments, bank lending has tended to remain tight and expensive to a majority of businesses. At some point in the imminent future, however, all the build-up of excess liquidity on bank balance sheets will have to be put to work in the real economy. At that point, despite Basel III compliance obligations, there is a likelihood of banks and other lending institutions expanding their loan books and loosening their lending requirements to win business.
In addition, non-bank, private sector players such as private equity firms, asset management firms and hedge funds are also expected to pursue their profit motive in this new phase of monetary expansion.
Inorganically created trillions of dollars of capital (fiat currency) is about to chase limited real resources and organically growing investment opportunities. The result: value of “hard stuff,” i.e. real, tangible assets (metals, commodities, natural resources, plants and machinery, infrastructure and real estate) is to grow over a secular trend line for the foreseeable future – albeit with a higher degree of volatility. The “hard stuff” also can be expected to out-perform the “soft stuff” (Software & Technology, Media, Entertainment, many parts of Financial Services, Hospitality, and other Services sectors, among others).
Hence, most of the world’s reserve currencies (US Dollar, Euro, UK Pound Sterling) are to come under pressure in this monetary expansionary environment.
Most currencies, in this period, can be expected to face a downward pressure but a few are also likely to stay resilient or appreciate due to the “flight to safety” phenomenon or because they belong to countries that are net exporters of raw or finished goods and services. Currencies that can be expected to strengthen are:
- currencies that have sound macro-economic fundamentals and fewer, more insulated fiscal and monetary variables to contend with (Swiss Franc, Swedish Krona); or
- currencies that are issued by large net exporters of natural resources or finished goods (Canadian Dollar, Australian Dollar, Brazil Real, Russian Ruble, Norwegian Krone, Chinese Renmimbi, Korean Won).
Pursuit of yield and the resulting fixed income bubble:
It may not seem like there is a profusion of liquidity in the general economy, yet the waves of capital are building up around the world and liquidity has already begun to creep into certain parts of the global economy such as a wide array of fixed income securities and emerging markets equities.
There are already signs of a bond bubble building up on the horizon.
Furthermore, central banks around the world are likely to continue to sustain a posture of extremely low interest rates to promote an increase in money supply thereby making a tight lending environment an unattractive proposition for banks and non-banking financial institutions. Government and corporate borrowings, on the other hand, will become ever more attractive to lending institutions’, corporations’ as well as institutional investors’, burgeoning balance sheets. The “promise” of a long-term steady yield would aggressively chase down returns in an otherwise uncertain environment. Therefore, fixed income instruments – whether sovereign debt, municipal bonds, or investment-grade (even high-yield) corporate debt – will increasingly become popular in this environment. Popularity, however, is not going to ensure high returns. Risk of a strengthening investor bias towards bonds is very real. Spreads – between high-grade and the enlarging pool of high-yield (aka junk) bonds – is expected to grow. Spreads – between fiscally austere and responsible governments vis-a-vis spendthrift economies, states and municipalities – is also expected to widen.
In pursuit of yields, investor appetite for high-yield fixed income securities has reached enormous proportions. This ravenous demand for high-risk fixed income securities, so recently after the Great Credit Squeeze, does not seem to abate even when it comes to high-risk sovereign debt such that of countries like Greece, Spain, Ireland or Portugal.
It is for the same reason why even the convertible bonds asset class can be expected to perform better than pure equities across many industries – particularly, the services-oriented industries. It follows that various forms of capital structure arbitrage opportunities are expected to present themselves in abundance during this period of dislocation and change.
It is in this setting that large, old-world behemoth corporations with steady cash flows and dividend payouts are expected to gain investor favor in the equity markets.
It is also noteworthy that, in early autumn of 2010, various Central Banks are still trying to fend off deflationary pressures both in word and in action – across many parts of the developed world.
The Fed, for example, is indeed in a fix. On the one hand, the US economy remains sluggish despite interest rates near record lows inching closer to zero. On the other hand, unemployment rates continue to trend upwards over – what can now be considered – a secular trajectory rather than a cyclical one.
Safety is the theme du jour: Defensible (not necessarily just defensive) industries that get “hands dirty”
So, how can we confidently utilize the above analysis to:
a) preserve capital;
b) grow capital.
It is quite straight-forward, really.
One way is to listen to what legendary investor Jim Rogers professes in terms of the merits of investing in “hot commodities.”
What companies would benefit from the “hot commodities” theme?
Metals & Basic Materials Producers: BHP Biliton (NYSE: BHP), Rio Tinto (NYSE: RIO), Vale (NYSE: VALE), Newmont Mining (NYSE: NEM), Barrick Gold (NYSE: ABX), Freeport-McMoRan (NYSE: FCX), Vedanta (LON: VED), Xstrata (LON: XTA), and so forth.
Energy Producers: Chevron (NYSE: CVX), ConocoPhilips (NYSE: COP), Exxon Mobil (NYSE: XOM), LUKOIL (PINK: LUKOY), Petroleo Brasileiro (NYSE: PBR), Royal Dutch Shell (NYSE: RDS.A), ENI (NYSE: E), among others.
What is noticeable is that a commodities boom will entail alternating cyclical demand for “risk on” assets such as oil, coal, gas, copper, etc. on the one hand and for “risk off” assets such as gold on the other. From a secular growth perspective, however, we are already in the midst of a bull run for both “risk on” and “risk off” commodities.
Capital flows, and consequent capital appreciation, can be expected to occur in miners, producers, harvesters, distributors and traders of commodities. We can fully expect for producers and manufacturers of consumer staples (particularly those with a global reach), basic and intermediate materials, and various energy sources — to see a significant increase in capital allocation as well.
In a multi-year period of de-leveraging across some of the highest consumption-driven (developed) markets, consumer staples can be expected to remain one of the few relatively stable sectors of the economy. Within the food and consumer staples space, companies like Kraft (NYSE: KFT), Nestle (VTX: NESN), General Mills (NYSE: GIS), ConAgra (NYSE: CAG), H.J. Heinz (NYSE: HNZ), Syngenta (NYSE: SYT), Monsanto (NYSE: MON), Bunge (NYSE: BG), and Archer Daniels Midland (NYSE: ADM) are likely to do well during this period. If agricultural commodities traders such as: Glencore, Cargill, and Louis Dreyfuss go public, they would be an attractive companies in which to buy equity as well. Their debt would also be an attractive way to gain exposure to the “food security” theme. Companies like Proctor & Gamble (NYSE: PG), Unilever (NYSE: UL), Johnson & Johnson (NYSE: JNJ), among others are expected to show resilience in the consumer non-durables space.
Our times, however, are not just characterized by rising values of “hard assets” such as: physical commodities, basic materials, and energy sources. Our times are not just about molecules found in nature. Our times will also re-discover the value of hard-to-replicate, “get your hands dirty,” industries like: infrastructure, industrials, utilities, telecoms, distribution and transportation.
The Industrials (Building Materials Suppliers, Construction and Heavy Equipment Manufacturers, etc.) would be attractive investment destinations. Leaders in this space will continue to demonstrate their dominance: Alcoa (AA), Lafarge (LFRGY), ArcelorMittal (MT), POSCO (PKX) are all positioned well to benefit from global growth in infrastructure and real estate development — particularly within emerging and frontier markets for years to come.
Utilities and Distribution industries would benefit from a “flight-to-safety” phenomenon. They would also be viewed as defensible businesses that are hard-to-replicate overnight. Utilities like Pacific Gas & Electric (PCG), E.ON (EONGY), RWE (ETR: RWE), GDF SUEZ (GDFZY), Gas Authority of India (532155) are bound to perform well in an environment of rising energy consumption and high barriers-to-entry for a new energy producer/distributor to replicate the extensive production, distribution and transmission network that these enormous utility companies have laid out over decades.
The Tech (and Telecoms) sector can be expected to retain resilient levels of demand and investment.
In a world of rising telecommunications usage coupled with dramatic adoption rates of first-time users in vast expanses of the developing world, those companies which have a head-start in their respective telecoms (particularly mobile telephony) markets are poised for significant upside. Examples that come to mind: Bharti Airtel (532454), Reliance Communications (532712), Brasil Telecoms Participacoes (BRP), VimpelCom (VIP), Turkcell (TKC), Vodafone (VOD), among others.
In each of the above mentioned sectors, the companies (and their securities) of the following types are expected to do well:
- clear and diversified market leaders, or
- the ones which have significant exposure to emerging or frontier markets, or
- the ones with dominant or monopolistic rights over raw materials, or
- those which are well-managed, low-debt, low-cost structures.
Fundamentals of companies in the ‘MINUTE’ space will point toward the best-performing equities and corporate debt — as long as — their securities are not over-priced vis-a-vis classic valuation metrics.
Fundamentals, at the end of the day, will differentiate the winners from losers even in the highest-performing sectors.
It is against this backdrop, that investors can generate superior risk-adjusted returns by investing in industries encapsulated within the ‘MINUTE’ theme.
“Welcome to your life
There’s no turning back
Even while we sleep
We will find you
Acting on your best behavior
Turn your back on Mother Nature
Everybody wants to rule the world
It’s my own design
It’s my own remorse
Help me to decide
Help me make the
Most of freedom and of pleasure
Nothing ever lasts forever
Everybody wants to rule the world…”
- Everybody Wants to Rule the World by Tears for Fears
Power Shift from West to East: Potential for Trade Disputes, Currency Wars and Protectionism
These are times characterized by structural changes in the global economy as the clichéd economic weight of the world shifts back from the West to the East (for fifteen of the past eighteen centuries, such has been the status quo).
These structural changes have only accelerated since the Global Financial Crisis.
Since the ensuing Great Recession, United States – the wealthiest country in the world – has now approximately one in five of its citizens living in poverty. Unofficially, 16% of the workforce is unemployed or under-employed. United States continues to run enormous trade deficits vis-a-vis China. China is buying American treasuries and United States is buying Chinese consumer products. As of now, it is in both countries’ interests to continue this policy of “mutual engagement.” The situation, however, is untenable.
Hence, the question is: Who will blink first?
Meanwhile, the UK is squeezed from many sides: rising unemployment, surging entitlement requirements, declining tax revenues, increasing need for economic stimulus, falling industrial competitiveness, and a general economic malaise. The country has elected its first right-of-center government (with a leftist coalition partner) in over a decade that is pushing through sweeping austerity measures to curb its out-of-control budget deficit.
Portugal, Ireland, Italy, Greece, and Spain are all dealing with enormous fiscal problems threatening the very existence of the European Monetary Union. There is a good possibility that we have not heard the last or the worst of the Greek fiscal woes or the Irish banking crisis. Default from either one of them cannot be ruled out.
Even hitherto fiscally robust economies like Austria and Belgium, are showing signs of economic strain.
The historically liberal, left-leaning post-World War II Western Europe seems to be building up a rising appetite for anti-immigration, right-leaning, populist tendencies. Nationalistic, anti-immigrant sentiments are beginning to manifest in electoral politics as well as in government policy across liberal and/or socialist heartlands such as France, Germany, Sweden, Denmark, and The Netherlands.
All of these are developed economies. All of these are some of the wealthiest societies in the world.
In this environment, overt or covert forms of protectionism are only a matter of time. Such protectionism, however, tends to help those industries more which are resource and labor-intensive — where jobs cannot be exported over a broadband connection. On this go around, however, there are fewer manufacturing jobs to protect in the West. As it is, the global manufacturing supply chain is extraordinarily intertwined where the component suppliers may be head-quartered in China, Taiwan, Malaysia, Indonesia or India. The final, branded consumer product, however, is – more often than not – designed in the US or Western Europe. Import tariffs, therefore, are not likely to trigger significant changes in global trade flows until and unless, the West brings about structural changes in its economies to support indigenous manufacturing to compete with cheap imports from Asia and elsewhere — particularly, those imports that are more competitive due to lower cost structures as well due to artificial currency depreciation. Any such structural change itself would take at least a generation to show marked effects in global trade flows.
The Eastern governments, for their part, would have to stop (or at least reduce) meddling with their currencies in order keep their exports artificially attractive in global markets.
Meanwhile, the currency row between the US and China is not just indicative of a growing tension between the Western (consumer) economy of the US and the Eastern (producer) economy of China. This currency row is a thinly veiled manifestation of the power struggle and transition we are witnessing from the West to East.
Ultimately, societies that “create” stuff (largely the West) should have more leverage than the societies that “make” stuff (largely the East). Intellectual property rights, however, cannot be as directly and completely measured, enforced and monetized as manufactured value addition. Hence, the West is being viewed as more profligate and less productive than the East and vice versa.
In fact, in very real terms, global trade and savings imbalances are partly due to this very phenomenon where the West is not being compensated in full — for its innovations in hi-technology, bio-therapeutics and conventional medicine, automotive, aviation, distribution and logistics, financial services, media, telecommunications, among other industries. The West is doing the innovation “heavy-lifting” only to see the East create a cheaper, faster, more mass-market version of the product or service that is sold across the globe without much (if any) financial compensation or intellectual acknowledgement offered to the original Western innovators of that product or service.
Meanwhile, the East is now beginning to move up the innovation value chain where it may, increasingly not only produce the products and services of the future, but may also originate the innovations of tomorrow.
As this shift occurs, power will be transitioned — from the West to the East – much like before in the history of civilizations in spasmodic, discontinuous bursts of instability and discord (if not all out combative military interventions or wars).
Global scarcity of resources, birth of new nations and a period of secular economic instability:
Historically, the world has dealt with scarcity for most of its existence. Make no mistake, despite armed conflicts in the past several decades not being as devastating or multi-lateral as World War II, the quest for resources continues to intensify among nations. In fact, one can argue that beneath all the cultural, religious, and linguistic differences that are offered up as the key bases for the independence struggles of various minorities, the central (although not always overtly stated) raison d’etre for new countries being carved out of existing ones is the notion of safeguarding ancestral, “sovereign” economic interests of a minority residing in a resource-rich territory within an existing nation.
Right from the mid-twentieth century – when former South Asian British colonies became independent as India, Pakistan, East Pakistan (later Bangladesh) – the pursuit of economic self-determination has been as much a factor as the desire for political autonomy or social equity and liberty in all independence struggles. Obviously, such a dynamic is not uniquely pertinent to the British empire either, the French relinquished their control over Indochina to give birth to three new nations for a similar set of reasons – Vietnam, Laos, and Cambodia.
Self-determination of political, social – and crucially – economic interests was the common thread across the founding fathers and the indigenous populations that catalyzed the break-down of the Soviet Union. Since the Communist union’s dissolution, a slew of new nations (many of which resource-rich) have come into being: Russia, Ukraine, Moldova, Armenia, Azerbaijan, Belarus, Estonia, Latvia, Lithuania, Georgia, Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.
East Timor became independent a few years ago fuelled by its quest for religious, cultural and economic freedom.
As a matter of fact, there have been rumblings for independence in resource-rich Kurdish Autonomous Region of Northern Iraq (popularly known as Kurdistan) for quite some time. Yet another example of economic drivers playing a significant part in seeking autonomy and independence, many in the Flemish region of Belgium want to separate from Wallonia – in large part, due to the economic disparity and dispensation structure of state-provided welfare benefits.
North and South Sudan may go their separate ways as early as January 2011. In addition to all the ethnic violence that has culminated in the proposed referendum for independence, South Sudan sits on over five billion barrels of proven oil reserves. Economics, again, becomes a critical consideration.
If we peel all the layers of the onion, as it were: Through the centuries and across geographies, the ongoing march of societies staking claim to resources they consider are rightfully theirs, has led (and continues to lead) to conflicts.
We are entering an era where, again, the quest for basic resources is expected to form the basis for many a major and minor future conflict — not just among nations but even within them.
As the sense of scarcity rises and the gap between ‘haves’ and ‘have-nots’ widens: anger, resentment and strife can be expected to follow. Recent strikes by workers in Greece and France over raising the retirement age and reducing entitlements, collective unrest in Pakistan and Haiti over the slow and inadequate response by their governments in the wake of natural disasters, as well as food riots in Mozambique are but a few manifestations of public anger boiling over. Despite those episodes not yielding the desired results for the ‘masses,’ we haven’t seen the last of them. Au contraire, if anything, we can expect to see more such collective manifestations of economic tensions brewing at the international, domestic, community, family unit and individual levels.
The writing is on the wall is: We are entering an era of secular economic and geo-political instability.
Hence, these times are about valuing the basics that sit at the bottom of Maslow’s hierarchy of needs: Food, clothing, and shelter.
“I close both locks below the window
I close both blinds and turn away
Sometimes solutions aren’t so simple
Sometimes goodbye’s the only way
And the sun will set for you
The sun will set for you
And the shadow of the day
Will embrace the world in grey
And the sun will set for you…”
- Shadow of the Day by Linkin Park
“Look thoroughly into matters, and do not let the peculiar quality or intrinsic value of anything escape you.” – Marcus Aurelius
What is Equilibrium?
According to the definition: Equilibrium is the condition of a system in which competing influences are balanced.
In Physical Sciences, the hypothetical interactions of constants and variables can be studied, proved or refuted in a controlled and/or closed system with a high degree of certainty that the expected outcome is uncontaminated by exogenous factors.
In Economics, however, one can argue that any theoretical proof and subsequent practical application of that economic theory should be able to withstand the rigors of operating in a system that is open, porous and influenced by both endogenous and exogenous factors. In essence, therefore, discussing the concept of equilibrium within the confines of a closed system derives limited value for economists, financiers, traders and other market participants as a closed system does not exist in the real, messy, dynamic world of trading.
In this context, may I propose the following hypothesis provisionally entitled: Perpetual Market Disequilibrium Hypothesis.
An open system such as a market — that is continuously and continually dynamic due to the individual influence and collective interaction of an inexhaustible array of endogenous and exogenous factors — cannot attain a state of “balance” of “competing influences” even for the most fleeting moment in time.
Due to the perpetual motion generated by information asymmetries, human emotions, investor sentiments, social perceptions, cognitive limitations, data inaccuracies, economic cycles, demographic transformations, systemic inefficiencies, structural problems, competing interests, global capital flows, global trade, policy shifts, regulatory loopholes, political expediencies, central bank interventions, etc. among market participants in an open system, the market is influenced by an inexhaustible number of variables the interactive impact of which is constantly changing and morphing the state of the markets in profound, imperfect, (and only partly fathomable) ways.
Hence, markets are in a perpetual state of disequilibrium and inefficiency.
Capital allocation, therefore, is also in a perpetual state of disequilibrium and inefficiency.
In philosophical terms, equilibrium or market efficiency is like perfection. It can be aspired for, but never attained. It is imaginary, not real.
In Classical Economic Theory, a “Dynamic Equilibrium” or market efficiency is a state when demand and supply intersect (and are in balance) with a resultant “equilibrium” asset price for that point in time.
The definition of “Static Equilibrium” in Physics is: A system of particles is in static equilibrium when all the particles of the system are at rest and the total force on each particle is permanently zero.
The definition of “Dynamic Equilibrium” in Physics is: The state of a body or physical system at rest or in un-accelerated motion in which the resultant of all forces acting on it is zero and the sum of all torques about any axis is zero.
In the study of markets, however, neither of the following conditions is true:
1. bodies or particles (market participants) are at rest,
2. total force (capital) on each body particle (market participant) is zero.
Furthermore, if we apply Burton Malkiel’s “Random Walk Theory” to the above definitions of “Equilibrium,” then particles (market participants) are not at rest but in a random “Brownian Motion.”
Equilibrium v/s Mean Reversion:
As discussed above, there is no universal, constant and determinate equilibrium price point from which the value of an asset can start, and to which it can revert, without consideration given to the length of time involved in the analysis. What is popularly referred to as Market Value (price) or the market equilibrium point, within a certain snapshot in time, is merely where demand and supply met for that particular instance in the price journey of an asset. Obviously, Time is the independent variable in the concept of equilibrium. Furthermore, as can be intuitively understood, an accurate identification of a so-called “equilibrium point” over a significant period of time would also require adjusting for inflation.
This, however, is where economists and other market participants begin to inaccurately mingle the notion of equilibrium or market efficiency with the concept of “mean reversion.” Conventionally, in Economics, the concept of equilibrium has been used mistakenly and interchangeably with “mean reversion.” The two concepts, however, are distinct.
Most asset prices (Market Values) can and do depict normal or “bell curve” distributions. Over a sufficiently long period of time with a sufficiently large number of inflation-adjusted price points, one would find that asset values do fall within a certain normal distribution, say, a 95% confidence interval. One can, in fact, isolate a “mean reversion” data point across a statistically significant number of data points over a pre-determined length of time for virtually all asset classes. This data point is, in certain circles, misunderstood as the “equilibrium price point” for a particular instance in time but it is not. By its very definition, such a data point is a “mean” or “average” of a collection of data points rather than being a solitary data point representing a moment when demand and supply intersected but were not necessarily in balance, i.e. so-called “equilibrium” or “market efficiency.”
The theoretical construct of an “equilibrium point” is that it is a singular and absolute data point where, in context of Economics for example, supply meets demand at a given instance in time. The theoretical construct of a “mean reversion point” is that it is an average of a collection of data points.
The “mean reversion” data point is misunderstood as an “equilibrium” price point within the relative confines of the data set identified just for a specified period of time. As the length of time under consideration changes, so does the data set and consequently, the “mean reversion” point. Therefore, even in the evolution of the price of a commodity or security, the “mean reversion” point is never a constant as it changes with the change in the time-frame under consideration.
Given the resolutely ephemeral and perpetually evolving nature of markets, equilibrium does not exist in absolute terms and it is misunderstood sometimes as “Mean Reversion” even in time-constrained, relative terms.
Intrinsic Value v/s Market Value (Price):
The other view one can take is that every price point at which a transaction is consummated is an equilibrium point for that fleeting moment till the next transaction ushers in the next equilibrium point supplanting the previous one, and so goes the story ad infinitum.
What we have is an all or nothing proposition. Either one can assert that there are as many equilibrium points as there are instantaneous transactions passing through a market (an open system). Alternatively, one can state there aren’t any equilibrium points because the market is constantly in a state of flux – either moving upwards or downwards due to the innumerable factors impacting it within infinitesimal segments of time.
The challenge with embracing the idea that there are as many equilibrium points as there are transactions, is that markets are inefficient at any given point in time. The price at which a transaction takes place is more a commercial compromise and less a true representation of the Intrinsic Value of an asset. In fact, the demand-supply dynamic is not necessarily an accurate or even fair determinant of an asset’s value. Demand-supply intersection is merely the most widely acceptable yardstick to ascertain the Market Value (price) (rather than Intrinsic Value) of an asset.
One may wonder: if not the demand-supply dynamic, then what is a better and more appropriate determinant of Intrinsic Values of assets?
As Marcus Aurelius says:“…do not let the peculiar quality or intrinsic value of anything escape you.”
The challenge of calculating Intrinsic Value is daunting because the notion of “mark-to-market” or reference points or relative prices is discarded in favor of ascertaining the Intrinsic Value of a particular asset to a specific buyer at a given point in time – notwithstanding how much Market Value (price) the seller or the other potential buyers are placing on that particular asset at that point in time. The ability to value (and price) assets based on the Intrinsic Value of the asset to the buyer is inherently a subjective process. Each valuer would arrive at different valuation figures despite using similar valuation techniques. Not to mention, each buyer has a different motivation and varying degrees of intensity for wanting to purchase the same asset at any given point in time.
For example, at a certain price point and time, a long-only value investor may not be as motivated to purchase the rising stock of Company A as the short-seller intent on covering her/his short bets on the same equity versus a momentum trader looking to ride the rising wave of the same company’s stock.
The proposition of purchasing an asset unhinged from its Market Value, i.e. price (which is largely predicated on the underlying demand-supply dynamic which in turn is based on a wide variety of data) can be a high-risk, high-reward proposition. Investment decisions made by “contrarian” (particularly, value investors or short-sellers) are often driven significantly by this “Intrinsic Value” ethos of investing where they have to trust their independent judgment about the “Intrinsic” or “Fundamental” value of an asset in the face of “Market Value” data that may vehemently negate their investment thesis. A contrarian investor has to take a bold, “against-the-grain” decision on determining the Intrinsic Value of an asset that may be mis-priced by a majority of the market participants either over or under the price band that represents the asset’s true “Intrinsic Value.”
The key distinction to be mindful of is the difference between Intrinsic Value versus Market Value (price) of an asset.
Market Value (Price) of an asset is determined at any given instance by market participants based on popular, realistic (not completely real) or distorted manifestations of the demand-supply dynamic. Intrinsic Value — within the context of Economics — can be defined by the utility that an asset provides to the user, owner, buyer or seller of that asset. The utility that is derived from a certain asset by a user, owner, buyer or seller varies from one to the next in a specific moment in time. The utility derived from a certain asset by the same user, owner, buyer or seller also varies in different moments in time. Hence, Intrinsic Value is a relative concept. Intrinsic Value is relative in terms of who is valuing an asset and it is relative in terms of when the asset is being valued. Each user, owner, buyer or seller is willing to forgo or sacrifice different units of work, i.e. money to procure the same asset under consideration at different times.
Market Value, on the other hand, is essentially the value (price) placed by the highest bidder for a certain asset under consideration based on all the available information available to him/her at that point in time. Hence, Market Value (Price) at any given moment in time is absolute and concrete. Intrinsic value — contrary to popular dogma — at any given moment in time is relative and conceptual (even elusive).
The difference between the Market Value (Price) and the Intrinsic Value of a particular asset is where the “Value Gap” lies. It is this value gap that can be exploited by the savvy investor to fulfill the profit motive. The skill, experience and intelligence of the investor comes into play in ascertaining an appropriate Intrinsic Value and placing an advantageous Market Value to procure the asset such that it beats other market participants before the Value Gap between Intrinsic Value and Market Value gets filled up by other investors who later grasp the extent of the market disequilibrium or Value Gap and act on it.
Sidenote: On a philosophical level, due to its relative and variable nature, Intrinsic Value is really not all that intrinsic afterall. In fact, it is extrinsic — as the value placed on an asset is dependent on the valuer of the asset and not dependent on the asset itself. Of course, this assertion opens up a whole new debate of whether Intrinsic Value truly exists and what is the distinction between Intrinsic Value and Extrinsic Value? Perhaps, such a discussion overturns over two thousand years of philosophical speculation from the days of ancient Greek philosophers such as Socrates, Plato, Aristotle, and Epicurus to more recent thinkers such as John Stuart Mill, Henry Sidgwick and William Frankena. It is a discussion suitable for another more philosophically-oriented piece of work.
Even within the confines of the above definition, Intrinsic Value can be relative as different valuers would value the same company’s plants, machinery, real estate, intellectual property at different price “marks” and hence again, Intrinsic Value is really more extrinsic, i.e. dependent on the subject (valuer) and not on the object (asset).
The Perpetual “Tom and Jerry” Game – In Markets, present (Market Value) is the past; future (Intrinsic Value) is the present:
Now, let us also look at another critical idea presented in the Efficient Markets Hypothesis: The price of an asset (security) at any given point in time has all of the information about that asset priced into it already.
Au contraire, if anything, the Market Value (price) of an asset – which is based on an aggregate mix of data, perceptions, opinions, judgments, rumors (Market Information) of the investment community follows Intrinsic Value of that asset. In other words, the ability of certain investors to profit from market disequilibria or inefficiencies clearly indicates a perpetual “cat and mouse” or “Tom and Jerry” game. Intrinsic Value is the Mouse (Jerry) after whom Market Value (Price) – the cat (Tom) is perpetually after. To extend the analogy – the distance between Jerry’s tail and Tom’s whiskers is the difference between “Intrinsic Values” and “Market Values.” This distance is the profit reaped by the agile and perceptive investors in this most complex, fascinating and perpetual cat and mouse game.
Hence, Market Values lag Intrinsic Values. The corollary of this assertion is: At any given point in time, markets do not have all of the information to arrive at the Intrinsic Value of an asset and hence at that point in time, markets are in a state of disequilibria. They always are. In a time series, at t-0, market perception determines the Market Value-0 ($100) of an asset but the Intrinsic Value of that asset is already at Intrinsic Value-1 ($120). Then at time t-1, market perception catches up and ascribes Market Value-1 ($120) to that asset. Meanwhile, here at that same instance t-1, Intrinsic Value of that asset has already bounced higher to $150. By the time the broad market catches up, perhaps, based on certain adverse fundamentals, the Intrinsic Value of the asset has now halved to $75. Meanwhile, Mr. Market is still celebrating the past at the $150 mark as if it were the present. Of course, Mr. Market does not know any better.
As the legendary ice hockey player Wayne Gretzky famously quoted: “I skate to where the puck is going to be, not where it has been.”
Intrinsic Values of assets do the same.
And so goes the story of “Market Value” chasing “Intrinsic Value” in perpetuity.
Whether it is through fundamental analysis or technical analysis or quantitative analysis or macro-analysis or some combination thereof, the few savvy investors who profit from assessing the Intrinsic Value of an asset – before the rest of the market participants catch up on the same or similar assessment – are the ones who are celebrated amongst the investment community as the ones possessing that “Alpha” factor.
What else would explain the profits reaped by legions of investors trading various assets on a daily, weekly, monthly, year-in-year out basis?
How is it that world-renowned investors such as Warren Buffett (Berkshire Hathaway), George Soros (Soros Fund Management), Jim Simons (Renaissance Technologies), Peter Lynch (Fidelity Investments), Bill Gross (PIMCO), Jack Bogle (Vanguard), Thomas Rowe Price, Jr. (T. Rowe Price) John Templeton (Templeton) among countless other “average Joe’s” have consistently not only generated profits in various capital markets – but have out-performed the markets by a wide margin – often uncorrelated with the larger economic cycles?
It is quite simply because they, undoubtedly, possess “Alpha.” They possess the much vaunted skill and ability to evaluate and perceive the “Value Gap” between the “Market Value” and the “Intrinsic Value” of an asset before the larger investing community — and these celebrated students of the market have the ability and gumption to act on it in a timely, calculated and effective manner.
The famed Soros trade against the Pound Sterling in 1992, or John Paulson’s massive short bet on the US housing market (and more particularly) the credit-linked derivative instruments in 2007, or Prince Alwaleed’s investment in the struggling Citigroup in 1991, or Jim Chanos’ short bet against Enron in 2001 – are all examples of high-profile investments where a savvy and decisive investor perceived a significant Value Gap prior to the majority of the market participants and made bets on the Intrinsic Value of those investments – only to see their bets paid off handsomely when the rest of the market finally closed the Value Gap between yesterday’s Intrinsic Value of the asset and today’s Market Value. In an instant of course, by the time the markets caught on to today’s Market Value “marks,” the Intrinsic Values of those assets had already moved on allowing a new set of contrarian investors to assess the new Intrinsic Values of those very assets and create new “marks” for what would be the Market Values of those assets at a later date.
This ability to successfully chase down Intrinsic Values of assets can be defined as the much sought after “Alpha” – the factor that distinguishes and explains the ability of certain investment managers to outperform the markets for most of the time.
Quantitative strategies pursued by Hedge Funds and proprietary trading desks of Investment Banks and other types of institutional investors have only been able to provide “Alpha” for a certain periods of time and to varying degrees of success due to a few reasons (elaborate later):
- Organic v/s Inorganic Investment Management: The structural rigidities and limitations of inorganic, logical, rules-based, linear, pattern-driven, algorithmic systems trying to model and out-smart the organic, often illogical, wild, non-linear, disobedient markets creates an environment of great disequilibrium in markets – especially as certain markets have come to be dominated by system-generated institutional capital flows setting the Market Value “marks” of certain assets;
- “Value Gap” Crowding Out: The computer-driven, quantitative strategies in pursuit of bringing the markets back from Disequilibria and close the Value Gap actually end up widening the Value Gap by crowding out the market by their large positions – especially when “Stop Loss” and other risk management triggers go off in their highly leveraged positions. In effect, similar quantitative, system-generated hedging “Alpha” strategies and risk management strategies at different institutional investors ends up crowding out the market for a given asset – thereby amplifying and magnifying the very Value Gaps or market inefficiencies or disequilibria they aimed to erase in the first place.
Therefore, human “Alpha” factor or human judgment will always remain the most precious resource in markets laden with, what Prof. Robert Shiller calls, “animal spirits.”
Effectively, both the Intrinsic Value and the Market Value of an asset are moving targets. Both, at the end of the day, are subjective. Both require a subject (valuer) to assess and ascribe an inherently subjective value to the asset (object) under consideration. Both, the Intrinsic and Market Values of an asset, do not have all of the information priced into the asset’s spot of futures price at any given point in time. It is just that Intrinsic Value P-1 is “closer” to the Fair Value of the asset at time t-0 but majority of the market perceives it to be Market Value P-0.
Ultimately, equilibrium or market efficiency is constrained to describing a momentary, ephemeral state (static or dynamic) for a market or an individual asset whose value (as stated above) is inherently, continuously and continually changing. Even in those conditions, however, equilibrium or market efficiency remains an imaginary state; a chimera.
It follows therefore, Equilibrium or Market Efficiency — in the context of Economics — does not even exist.
Application of “Perpetual Market Disequilibrium Theory” and “Value Gap Analysis”:
The concept of “equilibrium” is a cornerstone of Eugene Fama’s Efficient Market Hypothesis. As we have established above, neither is the market capable of being efficient, nor does that ephemeral moment called equilibrium ever arise. If Fama meant to use the “mean reversal point” in his famed capital markets hypothesis, he should have stated it as such — as we have also established that an “equilibrium point” is different from a “mean reversal point.”
The practical application arising from the realization that “Market Equilibrium Does Not Exist and Markets are constantly in a state of disequilibria” is:
As discussed above, the individual impact and collective interaction of numerous endogenous and exogenous factors (both facts and opinions) will ensure that, at any given point in time, markets remain in a state of imperfect information as they relate to the price of any given asset. The price of a given asset has built-in to it a variety of accurate and inaccurate perceptions of its value or worth. Mis-allocation of capital and asset bubbles, therefore, are bound to continue forming due to this perpetual state of imperfections or disequilibria in markets. Momentum investing is a phenomenon that speaks exactly to this kind of disequilibria where routinely markets over-shoot on the upside or downside from a range of price that can be deemed to represent a fair and reasonable estimation of the underlying value of an asset based on fundamentals.
With the advantage of ever greater levels of sophistication in data gathering and analysis, markets can aspire and work towards reducing the extent of market disequilibria (volatility) or the “Value Gap” between Intrinsic Value and Market Value at any given point in time. On the other hand, the very ability to share data instantaneously and ubiquitously also creates an enabling environment where both — fact and fiction (rumors, opinions, speculations, tactical misinformation, etc.) can spread equally effectively thereby magnifying and amplifying the interpolated impact of fact and fiction on the price of an asset.
Indeed, it is also this very perpetual disequilibria that contributes to the opportunities for market participants to wrench out inefficiencies and profit from them on an ongoing basis.
A practical application of the Perpetual Market Disequilibrium Hypothesis is that, for a savvy investor, there are always opportunities to exploit the Disequilibrium or Value Gap for an asset at any given point in time. It doesn’t matter whether the market values (prices) or volumes are on their way up or down. In fact, from a value investing perspective, there is potentially a greater number of opportunities during a “down” market for an investor to enter the market and exploit the “Value Gap.”
For example, as illustrated in the chart below showing Goldman Sachs’ two-year stock performance, just as investors started to move to the sidelines in April, 2009, i.e. trading volumes began to get lower, Goldman’s stock began to climb to reach its two-year highs in September, 2009 when trading volumes were at one of their lowest levels for that two-year period.
The strong negative correlation between prices and volumes depicts the “Value Gap” phenomenon in all the more pronounced and compelling manner because Goldman’s stock performance in the chart below is coming off the lowest point of the biggest financial crisis since The Great Depression. For nimble, contrarian investors with an eye for identifying the Value Gap between the Intrinsic Value and Market Value of an asset or a security, Goldman presented an extraordinarily profitable and uncommon buying opportunity during this period of great uncertainty and disequilibria. Given the trading volumes during those four quarters (April, 2009 to March, 2010), there was less competition to purchase the stock as it began its long climb, and there was greater upside potential for those investors who recognized and seized the Value Gap as the stock went up. The key was to remain patient and confident about one’s judgment on the Value Gap. Ultimately, the application of the Value Gap concept is not ideally suited for rapid, short-term or intra-day trades. It is better suited for medium-to-long term trades where market perception or “technicals” catch up with the “fundamentals” of the asset under consideration.
Conclusion: Due to the complex dynamic of a constantly, endogenously, and exogenously changing demand-supply system, markets are never in a state of equilibrium. To state that the concept of equilibrium exists, therefore, can be arbitrary, subjective, and plain inaccurate.
“Gateway” or “Spiky” markets are likely to lead the way out for the Real Estate asset class
Investment Context & Opportunity: Tier-1 “Gateway” Cities
Savvy, intrepid, independent-minded — particularly, contrarian — investors ought to pay close attention to real estate in global “Gateway” cities.
Gateway cities, or “Spiky” markets, can be defined as a set of global Tier-1 cities to which Prof. Richard Florida’s “Creative Class,” or even roughly, Prof. Anna Lee Saxenian’s “New Argonauts” flock.
The following metropolitan areas would constitute Tier-1 Gateway markets: New York, London, Tokyo, Bay Area (San Francisco and Palo Alto in particular), L.A./Orange County, Sydney, Miami, Toronto, Vancouver, Bombay, Rome, Munich, Paris, Moscow, Dubai, Istanbul, Sao Paulo, Shanghai, Singapore, Hong Kong.
Many of these Gateway metropolitan areas’ high-end real estate is presently under-valued by anywhere from 30 to 60 per cent vis-a-vis their historic inflation-adjusted peaks. With values of high-end real estate inventory at such dramatically low prices across many of these Gateway markets, now is the time to take some bold investment decisions.
Due to continued urbanization, these cities are on their way to transforming themselves into megapolises over the next half a decade or so. Many of these Gateway markets already enjoy megapolis status. Due to the natural limits to their expansion and the constant real estate supply-demand “cat and mouse” game, real estate prices in these markets can be expected to climb along a secular trajectory over the long-term — particularly for high-end real estate. Even in the short-to-medium term, however, these markets are likely to rebound and outperform real estate markets in smaller Tier-2 cities.
Furthermore, “network effects” or “multiplier effects” will continue to lead to a disproportionate increase in productivity in these cities compared with their Tier-2 Gateway peers (identified below). As the world comes out of the “Great Recession,” the productivity enhancements in these Tier-1 Gateway cities will get priced into the real estate asset values before (and higher than) they would in other smaller metropolitan markets. Like people, capital will be more fluid through these highly “porous” global cities. Hence, real estate assets in these Tier-1 cities will be more liquid than assets in other Tier-2 cities.
Starting now, Hedge Funds and long-only PE firms can take advantage of these opportunities by investing in landmark Grade A office space, 5-star hotels, upscale retail destinations and even marquee residential property.
Obviously, Gateway cities in certain emerging markets like Shanghai and Bombay are an exception as the real estate asset values in those markets have reached, and even exceeded, their 2008 peaks in certain instances. Infact, a credible argument can be made that high-end real estate prices are inflated in some of those emerging markets — particularly in Shanghai and other major Chinese metropolitan markets like Beijing, Guangzhou, Shenzhen, Tianjin, Hong Kong, etc.
Arguably, even “over-priced” real estate assets in emerging markets are likely to prove to be sound investments over the next half a decade and beyond. No rocket science. It is simply the crushing force of demographics that will raise price levels for virtually all forms of real estate in these centers of economic and cultural activity.
Furthermore, a small portion of this strategy could be devoted to specialized REIT’s with significant exposure to the above mentioned geographies.
A smaller amount of capital can also be devoted to higher beta, Tier-2 pool of global “Gateway” cities as well.
These would include: Chicago, Boston, Atlanta, Montreal, Rio De Janeiro, Buenos Aires, Cape Town, Melbourne, Bangalore, New Delhi, Milan, Madrid, Frankfurt, Amsterdam, Copenhagen, Stockholm, Brussels, Dublin, Vienna, Prague, Seoul, Beijing, Kuala Lumpur, Abu Dhabi, Cairo, among others.
Investment Entry Horizon:
Next 6 to 18 months would be the “sweet spot” for picking up the choicest assets without contending with bruising competition.
Investment Exit Horizon:
Next 36 to 60 months — depending on the Gateway city in question — would allow for an optimal period for healthy returns on exits.
10% to 20% annualized IRR (depending on which particular market is considered).
Roughly 5% of a diversified Hedge Fund’s total assets under management (AUM) could be a good place to start. Given the scale and scope of this investment strategy, it can absorb as much as 10% to 15% of a fund’s portfolio as the geographic diversity (North & South America, Western Europe, Russia, South Asia, Middle East, and East Asia) asset variety (Hotels, Offices, Malls, and Residential real estate) provides a natural hedge to a portfolio designed with such an exposure.
Fresh capital infusions from a fund’s limited partners would allow a fully or mostly-invested fund to expand its asset base without compromising on its investment philosophy, expected returns, risk management controls, or capital allocation/portfolio diversification principles.