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Front-Running Liquidity

Front-running liquidity has been a terrific investment strategy for Mark and I over the years (and NO, it has nothing to do with getting drunk before everybody else).

It allowed me, before reaching the ripe old age of 30, to wake up one morning realizing that, “Hey I don’t have to get outta bed ever again if I don’t want to…” Despite that reality, my children make sure I’m up and around at O’dark:30, regardless!

Front-running liquidity is relatively easy, so much so that I’m convinced anyone can do it. It’s a critical component of our investment thesis. The saying goes “keep it simple stupid” and it is very true.

For illustrative purposes let’s show how liquidity can be produced in a small, localized community. Learn and understand the methodology. Use it when looking at global markets, stocks, bonds… anything really.

Example:

Imagine a large block of land, 1500 acres, on the outskirts of a town. It is selling for US$10 million. How much demand exists for a block of land this size, at this price?

Answer… Very likely, not much.

It is certainly less demand than for a block half the size and price, and less again for 1/2 acre blocks at a fraction of the price.

Now, run an interstate highway straight through these sections of land. Throw in a gigantic mall filled with retailers selling crap, and demand goes through the roof!

Put trailer homes on top of those 1/2 acre blocks and your Jerry Springer faithful would be chomping at the bit to get a piece of the pie. Put upscale homes on these same sections of dirt and we have a completely different clientèle. Regardless though, we have taken something that was illiquid and turned it liquid.

Now, let’s do some quick “back of the napkin” math with a fictional developer (we’ll call him Bob). Along comes Bob. Now, Bob is a guy who has a little foresight and has done his research regarding where infrastructure is being proposed by the local council.

Bob buys the land and spends another US$2 million subdividing it. He runs water and power to each site and pays the attendant local council bribes, uh… I mean “fees.” This gives him a cost basis of $8,000 per half acre lot.

Question: Now what is the price for a 1/2 acre lot?

For sake of example again, let’s say it’s US$50,000. That’s a 625% ROI. Nice going Bob!

What’s changed?

Liquidity. Simply stated there exist far more buyers who can, and are willing to, cough up US$50,000 per lot than those prepared to cough up US$10 million.

This is obviously a simplified example, but:

Asset + Liquidity = Demand.

Adding liquidity can be done by adding value yourself, or simply by waiting for liquidity to come to certain markets, companies, etc. and buying ahead of it.

What I described above is also front-running infrastructure. The infrastructure provided the liquidity in this example. Our developer (Bob) would have made a ton of money by simply land banking, and waiting for the highway and mall to be built.

Now you see why so much of what Mark and I do is in the private equity space, and in markets which typically have low liquidity, yet where we believe that liquidity will, or is improving. This is how fortunes are made…

  • It is why we recently invested in a Mongolian IPO;
  • It is why our friend Harris Kupperman has positioned his firm ahead of the wave of liquidity coming into the real estate and insurance sectors in Mongolia;
  • It is why I’ll be spending more time in Myanmar this year looking for a way to invest my capital intelligently,
  • It is why Mark invested in a seed round for a hydro deal in Nepal;
  • It is why investing in Indonesia some years back proved so lucrative. (Frontier markets can give you multiples on your money provided your thesis is correct, and the liquidity comes);
  • It is also why we are investing in an incubator with proven management ,who have taken multiple businesses public or initiated trade sales, both of which amount to providing liquidity for investors.

Let’s blow the scale up a bit and look at front-running liquidity in emerging and frontier markets.

Right now in Myanmar changes are afoot. Sanctions are being lifted in a country, that while dirt poor, is bountiful in resources and geographically well-positioned to benefit from free (or freer) trade.

Foreign players (including your’s truly) are literally sitting on the borders waiting to rush in. Prices have already rocketed higher on domestic-driven investment from the wealthy in-country. They see what is coming and are positioning ahead of the inevitable wave of (foreign-driven) liquidity. I’ll talk more about this as my “on-the-ground” intelligence accumulates.

The challenge in these instances lies in finding a decent means of participating. Oftentimes we’ve had to simply let some opportunities go, since it is impossible to be everywhere, all of the time. It’s dilutive to devote one’s time to too many projects, as tempting as they may be.

The flip side of this is that when liquidity dries up, and capital turns and runs for the exits, the same opportunities exist. We believe this is what is going to happen in the Japanese Bond and currency markets shortly. More on that next time.

- Chris and Mark

“Coming from such a low base-level any incremental improvements in standards of living can lead to incalculable gains for investors.” – Harris Kupperman, CEO Mongolia Growth Group