Finding mispriced investment opportunities

7 minutes  

Take outs:

  • Market anomalies give rise to investment opportunities which can be used to meet investors objectives.
  • Important factors to finding anomalies - knowing what to look for, where to look for it, insight, judgement and intuition.
  • Government bonds are an example of current market anomaly - an investment opportunity due to abnormally low interest rates and the market’s reluctance to believe they are now rising.


What does investing and a baseball movie called Moneyball have in common?

Quite a lot according to PM Capital Founder and Chief Investment Officer Paul Moore who uses the movie as an analogy for the opportunities that can be found in mispriced stocks.

The difference of course between the movie and funds management is that Moneyball is the story about an American league baseball team, the Oakland A’s, who created the longest winning streak in the game’s American League by taking an opportunistic approach to buying players for the team.

“They had to do it because they had a limited budget versus the big teams so they had to find these mispriced players,” explained Moore.

He said such an approach can also be used in funds management because there is an “imperfect understanding of where investment returns come from.”

Presenting as part of the Netwealth webinar series titled ‘Investment Moneyball: Taking advantage of market anomalies, Moore said he first came across the concept of market anomalies in the 1990’s when stocks in US bank Wells Fargo were undervalued, partly due to its exposure to commercial property.

However, the anomaly here was Wells Fargo’s valuable deposit franchise business and its underwriting of credit was being overlooked.

Moore said after 26 years, Wells Fargo delivered a 13% compound return plus dividends, despite world events such as the GFC and Twin Towers.

Other examples of market anomalies include the ‘old economy’ stocks being ignored during the tech mania back in 2000, or during the GFC when there was a significant opportunity to invest in both equities and debt.


What makes market anomalies possible?

Quite a few factors, according to Moore, including humanistic factors such as fear and the avoidance of pain.

Another factor is lazy research. Moore said too much reliance on labels such as ‘blue chip’ stocks and well-known brands means stocks are often not what they seem.

Short term focus also has a role to play in market anomalies because people price in changes in the investment or competitive environment as permanent rather than transitory. Further, distractions such as changes in regulation and changes to super can lead to a standard risk-based model asset allocation type approach and passive investment.

A case in point is the market’s reaction to the election of Trump.

“All the market investors placed their bets; they all thought that the markets would collapse because Donald Trump got in and what a disaster it would be,” said Moore. “But at the end of the first US market session after the election the markets had not collapsed. The markets went up because they were focused on the fact that a log of core policies were about deregulation, productivity initiatives which is actually positive for the market.”

He added: “Even when the market knew the answer, they made the wrong investment decision.”

Conflict and misunderstanding is another generator of market anomalies, and is the basis for Moore’s aforementioned Moneyball analogy.

“People who run ball clubs think in terms of buying players. Your goal should be to buy wins, to invest in businesses that will give you a required return on capital.”


Finding anomalies

Moore said the major important factors to finding anomalies are knowing what to look for, where to look for it, insight, judgement and intuition.

He said all five factors have played a part in his business’s 15 global brewing investments made since 2003.

“Back in 2003, the European brewers were selling on 10 times earnings, whereas Budweiser, an American brewer, was selling on 20 times. It was the intuition that the industry was globalising that led us to us investing in brewing companies.

“We believed the global brands, which were largely owned by the European brewers, would become the dominant brands. Also 3G, who were a dominant shareholder in a Brazilian brewing company, wanted to diversify out of Brazil, so over the next 15 years we used this knowledge and invested in several companies that they subsequently acquired.”

When selecting a fund manager, Moore said conviction around investments comes from having a clear objective. Background research and asking the right questions is more important than how many companies the fund manager visits.

“Typically, when we go on those visits, we're only looking at one or two key investment ideas and we've typically got only one or two key issues that we're really focusing on. It's better to know a lot about a little, than a little about a lot.”

Another hard part of the equation is knowing when to invest, or as Moore calls it, to pull the trigger.

“There's never an exact time but you've got to base it on valuation. Whenever the valuation of a company is far enough away from the stock price, that's when you invest, that's when you pull the trigger.”


Anomalies right now

Moore said Government bonds are currently a glaring anomaly in the market due to the record debt around the world as well as record low interest rates on that debt.

“If these governments were companies, they'd be junk bond status.”

Interest rates are low because the monetary authorities have been buying bonds to try and keep interest rates down. However, this will change as the government transitions its policies.

In terms of managing portfolios, if investors are taking a passive approach they are earning between 0-2% returns on cash and government bonds, 3-4% on property and at best, 4-6% on equities.

“What that means, is if you blend that into a portfolio, investors, savers, pension funds, they're not going to meet their objectives,” said Moore.

For this reason, he believes fund managers with conviction and patience are a more reliable way for investors to meet their objectives.

To hear the full presentation, ‘Investment Moneyball: Taking advantage of market anomalies’ or click here if you would like to speak to someone from Netwealth.


Any reference to a particular investment is not a recommendation to buy, sell or hold the investment. The relevant disclosure document should be obtained from Netwealth and considered before deciding whether to acquire, dispose of, or to continue to hold, an investment in any Netwealth product. *To June 30 2017.

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