Returns Inverse-Square Code (RISC)
Experienced investors are well aware the risk is not a lever that should be increased to improve upon the returns, but, that risk should be minimized at all levels, individual investment, portfolio and the country level.
As I have been investing in the international markets for the past four years, there is another RISC™, an acronym I came up with, that investors need to be aware of. Sometime back a term I made up was SWeT Effect™ here.
To explain what it means, the Inverse Square law states that a specified physical quantity or intensity is inversely proportional to the square of the distance from the source of that physical quantity.
For us as investors, I meant to imply that the probability of finding and consequently the returns from small / micro caps are inversely proportional to the eye-balls watching a particular market. i.e. Returns are likely to be greater in the market with less eyeballs and intelligence chasing the small caps. Since this is not a law but more of a guideline / code. Hence the acronym R-I-S-C. In micro caps, the returns will be inverse to the square of eyeballs / intelligence.
To provide with an example, there are ~4000 companies listed in Canada (population 35 million) whereas ~10,000 companies in the US (population 320 million), there are significantly more opportunities in the small cap space in Canada than in the US market. Vicinity to the US also makes Canada fairly priced. The US market is of interest to investors in the other parts of the world, hence further dearth of micro / small cap opportunities in the US.
So, a micro cap investor must avoid RISC™ as well as conventional risk.
It is true that there is plenty of money to be made in a Walmart after it has been well discovered after ten years or even now in an HDFC Bank which has already been a 100+ bagger to compound decently. This RISC is more about finding micro caps.
I personally find it easier to find micro cap opportunities in the markets with a few thousand equities listed rather than 50-100 as is the case with most African markets.
Value Investing Message is Well Heard
Contrary to what WB may have said in the past, the value investing message is now well communicated and advertised.
Just an example, a 300 Million AUD company has bought a Value Investing Coaching company in Singapore http://www.asx.com.au/asxpdf/20160125/pdf/434kcf2hr6jhhb.pdf that educates people and writes Moat Report etc. so there will be less money to be made in the Moat Stocks in my opinion going forward.
Super normal returns, in my opinion, will be made in cyclical stocks, sector turnarounds, leveraged trades, and finally the overlooked segment i.e. micro / small cap. From a 2-3 year perspective, it will be very hard to find good companies that can outperform. In India, even in the micro and small cap space, despite only 2.5% of the Indian population investing in the equity markets directly, there aren’t any micro caps opportunities worth investing. By worth investing the definition is a debt-free company growing over 20%, leader in its niche and a single digit PE.
A third, fourth rung housing finance company with poor processes selling at 35 PE multiple eg: SRG Housing Ltd. in India in a sector where small size has no advantage or large size has no disadvantage does not count (Not invested in SRG Housing). I also find people investing in India to be fairly intelligent, hence the lack of opportunities in the small cap space.
As per this analogy the most likely market is the one which has the least eyeballs and the most listings per population. This year I found Australia to be one such market.
Recall that its still very hard to spot good companies, of the 60,000 companies listed on the planet, less than 100 experienced 22% revenue growth, net profit growth and ROE above 22% for the recent five year period. I guess we need to keep that in mind at the same time, while being impressed with books from Thomas Phelps and the like.
Emerging Countries to Score Economically
California’s GDP is 2.4 Trillion (population 40 million), it does not take a genius to guess that India will surpass it soon with a mere GDP of 2 Trillion (population 1300 million). The GDP and returns in the equity market do not have a very good correlation. Interest rates have a better correlation.
EU GDP PPP was 12 times China’s GDP in 1980. Today China’s GDP is larger in PPP terms than EU GDP.
I cannot talk about the quality of life improvement, but most of the global economic growth will come from Asia over this decade. 94% of ship building industry is based in China, Japan and Korea. 4.5 out of 6.5 billion people live in Asia, so it follows naturally.
In the graphic below, the area in the red (Bangladesh, West Bengal and Bihar) represents 5% of the global population and the rest of the blue area also the other 5% of the global population. That is a strong case for investment in the emerging and underdeveloped countries.
Despite the attractiveness of international investing where the
puck eyeballs have not been, the exchange rate / currency risk is very real. Nigeria has seen the currency fall from 150 Nigerian Naira in 2014 to now 300+ against the USD. I lost few percentage points here. Syria currency was 48 to a USD in 2011, to now 625 against the USD.
I guess there isn’t much to wail if you earn 15% in real terms while the Swiss, Danish, Swedes and Japanese earn negative returns on their bank deposits.
Man = Monkey plus a little something
While I wax eloquent on the RISK and its cousin RISC, there are other problems in the world which warrant more concern.
I was astounded to read about 22 plus suicides a day by the US Military Veterans (which according to research could be understating actual numbers). https://en.wikipedia.org/wiki/United_States_military_veteran_suicide
Also, pretty disappointed with the leadership of this monkey called Homo Sapiens (an acronym of convenience, cleverly selected as Sapiens meaning wise [to massage one’s own ego]) in spending 3.4 Billion USD on a single plane like B2 Spirit. Surely, there are better projects one can conceive of that get us ahead.
Disclosure: Views are personal notions and do not represent any organisation or company. I am not an investment adviser. Investment in stock market can (and many a times do) result in loss of principal capital.