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Long Term Investment Management represent the thoughts of Alessandro Sajwani, a Senior Investment Advisor for a large European Bank. This site selects a sample of articles from the Long Term Investment Management blog. I was originally trained in Physics, where I went on to research the... More
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  • The Asset Play as an Investment Strategy
    In our view markets are currently being priced assuming an optimistic growth scenario for the economy in general. As a result, LTIM are now reducing positions in cyclical companies/sectors/industries. We should add we are finding it harder to purchase companies at good prices considering their stable earning power.

    A good price is a rather subjective concept, confirmed by speaking to several investment advisors whom will give several different responses. For LTIM it has a rather precise concept. It means we pay a reasonable multiple for stable free cash flow generation, whereby the yield we expect to receive at the price paid is higher than the return we expect to achieve from our portfolios (which is cash rates + 3% over a three year average). As a result, any growth will effectively come for “free”. At current market prices, few companies are offering growth for free. Hence our difficulty in purchasing companies on a stable earning power basis.

    However, we are not building up a cash position larger than 15-20% of the portfolio in an environment where inflation risks seems to be increasing. Whilst we are reducing cyclicals, we will not simply wait for the next market crash to occur. Whilst growth assumptions have to become more aggressive to purchase a stream of future earnings, companies trading at market prices below their net physical assets are still available in certain industries. This is the domain of the asset play strategy. In this domain, net physical assets are at least as important as future free cash flow.

    Asset play strategies usually involve the purchase of companies that are currently unloved. Investor demand for visible earning growth ensures that earnings, rather than assets, is the variable markets are most sensitive to when placing a price on a company that is publically traded on a stock exchange. We see this from the way stock prices shift aggressively if reported earnings are greater or less than estimated, by the format of analyst reports that emphasis the earnings evolution of a company in the next 12 months, as well as the way companies are crudely valued by many market participants applying a multiple on estimated short term earnings.

    This focus on short term earnings can be physically measured by viewing how investors are allocating capital in the equity markets. For example, in the US the average holding period of a common stock in 1940 was around 7 years. In 2007, the average holding period was 7 months. It seems no one wants to forecast a companies earnings beyond 2 quarters. That seems to fit in well with what my hedge fund buddies say, and do.

    The aim of the asset play is to try and take advantage of this “time arbitrage” that seems to exist in publically traded securities. It is common knowledge that certain asset heavy companies that suffer cyclical stress or poor news can be bought on the secondary market at a price considerably cheaper than their net real assets. However, assets plays can remain asset plays for a considerable period of time, which can dilute the potential return of the investment strategy.

    In LTIM asset plays we therefore look for a specific catalyst that can reveal the hidden value within a companies balance sheet. In this environment, for a short period of time, the assets can lead the stock price, as opposed to the earnings. Marty Whitman would refer to such a catalyst as resource conversion, an important source of return for the value investor. The catalyst usually comes in the form of a new owner holding the asset. Hence relevant market transactions would be a new aggressive passive or majority shareholder, a merger or acquisition, or the selling of assets. Such a market based transaction can make visible the discrepancy between the price of the asset on the balance sheet and its true value in the market. As a result, the price to book ratio expands.

    Asset plays are an interesting diversifiaction in a portfolio when growth assumptions become too aggressive, as is the case now for many companies we would like to own, but are not happy with the prices they are currently available. Furthermore, for those investors who fear inflation, such asset plays are an interesting way to gain access to physical assets at a relatively good price, which does not seem to be available via purchasing commodities via spot or futures markets at the moment.

    In practice, we often combine an asset backing with a stable earning power assumption. As a result we feel comfortable the potential for a permanent loss of capital is minimal due to the net assets behind the company if a liquidation was to occur, whilt any growth in future earnings will come for free. As a result returns are likely to come from earnings, but a resource conversion event is a possible bonus. We like the risk -return characteristics of such investments when the price is right. Many opportunities are being provided in such unloved sectors as real estate - a sector much loved by everyone only a few short years ago...
    Dec 27 2:53 PM | Link | Comment!
  • A Glorious Time to Enjoy Risk Assets...
    Well, it looks like we passed 1,200 on the S&P 500, the FTSE 100 passed 5,800 and just about every equity market is rallying, presumably because investors have decided that central banks will try and inflate asset prices to help boost "consumer confidence".

    Many of you have increased equity exposure to 40%, a suitable exposure to this asset class at the moment. I must admit, personally, I am starting to put on my selling hat. We suggest you consider getting that hat out of the cupboard and dusting it off.

    Though recent news is a powerful boost to asset prices, we seriously doubt pumping asset prices with morphine (i.e. increasing the price of a piece of paper), will be the long term solution to slow growth in developed economies. These are structural problems that depend on the cost of labour, the skills of a countries people (i.e. education, attitude etc) and their demographics. The debt burden is of course an important issue. As a consequence, the role of morphine is most uncertain.

    Investors are suggesting enjoy the party, don't fight the FED, overload on risk assets. In the short term, this may well prove to be the most lucrative strategy. However, we express a sound of caution. It is a probable event that the drop will be faster than the rise if:-

    1. The last drop of morphine is injected and their has been no "perceived positive outcome". Furthermore, It still is not clear to me what the criteria is to deem the project a success

    2. Your body has after effects on the morphine....inflation...other central banks react....

    3. You become addicted.............Markets drop unless QE keeps continuing...

    The environment is being created where speculation is the game, not investment. The best predictor of an investments performance is its entry price relative to its underlying value (clearly a subjective concept). However, I believe that is as good as it gets. Understanding that Mr. Market has mood swings is beneficial to getting the right price, attempting to predict them, is a more dangerous game.

    Though it seems likely that within the next 6 months the S&P 500 could reach 1,300, if this occurs, your return will have little to do with company valuation relative to political meddling.

    This distortion of asset markets is most worrying. Though with valuations as they are I would be normally making a louder noise to sell risk assets, the continuous intervention by politicians means there could well be room for further distortional rises in pricing. However, I suggest to all that your selling hats should be close to hand and that cyclical or capital intensive companies you have bought over the last 12 – 18 months, you should consider taking at least the profits. Being dependent on your local politician for a quick buck....need I say not a dependent strategy. Only high quality companies, as an equity category, offer a relatively sound valuation at the moment.

    Apologies for my bickering, but everyone has become so positive that I feel obliged to remind us that we quite possibily living in an illusionary world.. it may last longer than a honey moon, but buyer beware.......
    Nov 07 2:31 AM | Link | Comment!
  • Love the Americans, they love us
    Protectionism...what a cold and unwanted word.

    Many media sources are warning on its impending impact, whilst others are more optimistic by the fact many are already worrying about it, rather than cheering it.

    However, I do believe we have a fine tonic of protectionism already going on, a la sophisticated.

    By promoting equity markets and weakening the USD by promising more quantitative easing, effectively, you boost the wealth of Americans (in USD terms), but it is harder to spend that abroad, due to the weaker USD. Hence, it makes buying American the best option.

    This seems like a fantastic idea to increase US consumer confidence. As we have discussed in previous blogs, consumer spending can increase when one, or all, of the following pillars are positive:-

    1. Wages are increasing, unlikely with high unemployment
    2. Credit is expanding, unlikely with the financial and consumer sector de leveraging
    3. Asset prices are increasing: quantitative easing is trying to boost this factor

    Let me repeat, what a fantastic and tacit way of increasing the "wealth perception" snd hence confidence of Americans.

    However, there is one problem. When every country trys to play the same trick! The solution then becomes a problem. A many trillion USD problem. Because if all countries apply the same strategy, everyone wastes money, because no value is created and no permenant relative loss in currency will be achieved. It is this road that we seem to be going: and what an awful road it can be. Hold on steady chaps its going to be a rough ride, and as each day passes, it becomes harder to turn back!

    It is for this reason we must apply inflation protected strategies in portfolios, to help us from having our portfolio potentially permenantly de valued from reckless money creation. Remember, financial instruments are priced in currency: the currency issue cannot be ignored.
    Nov 07 2:30 AM | Link | Comment!
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  • Is it not concerning that bonds are pricing problems, equities a recovery whilst gold inflation?
    Jun 13, 2010
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