We reckon equity is an key incentive
We reckon that the managers and directors most aligned to maximising shareholder value will be those with a considerable portion of their wealth tied up in equity in the business they are involved in.
Earlier today we used software group Reckon (ASX code: RKN) as an example in this post on livewire. In discussing RKN, we touched very briefly on the evidence backing up our logic on equity incentive.
We discuss this further in Equitable Investors' paper on the factors and inefficiencies we seek to capitalise on as part of our investment process: "Seeking Advantage - Focusing on the Underlying Drivers of Excess Returns Most Evident in Smaller Companies to Optimise Investment Portfolios for Return and Risk". You can find the paper at www.equitableinvestors.com.au or by clicking here.
Or you can read our earlier blog entry on Alignment of Interest here.
Fundamental anomalies are better explained by mispricing
If you've read our "Seeking Advantage" paper (available here) you would know that Equitable Investors believes in fundamental inefficiencies in equities markets. And those views were reconfirmed by a piece of academic research that considered over 18,000 fundamental signals, concluding that:
- "many fundamental signals are significant predictors of cross-sectional stock returns"
- "This predictive ability is more pronounced following high-sentiment periods and among stocks with greater limits to arbitrage"
- "fundamental-based anomalies, including those newly discovered in this study, cannot be attributed to random chance, and they are better explained by mispricing"
The research paper, "Fundamental Analysis and the Cross-Section of Stock Returns: A Data-Mining Approach" can be found on the University of Missouri website (here) or you can read a summary from CFA Institute (here).
Consistent with our view, the research finds evidence consistent with the expectation that "the predictive ability of fundamental signals is more pronounced among small stocks".
The top-ranked signal is change in LT/LAGAT (change in total liabilities divided by lagged total assets), with a monthly alpha of −0.74%.
We won't translate all the abbreviations in the table below but we're sure you can work them out.
List of top fundamental signals based on t-statistic
source: Fundamental Analysis and the Cross-Section of Stock Returns: A Data-Mining Approach
New commentary up on livewire: An overlooked small cap agri stock
"When your competitors go one way, do you follow them, or do you go the other way?" That question was asked of a room of close to 100 financial advisers by keynote speaker Geoff Ramm at Centrepoint Alliance's annual conference last week. The focus at the time was effective marketing but resonated with this investment manager in a different context.
The stocks that contributed most to the performance of the Equitable Investors' Dragonfly Fund in the month of September were clear cases of neglect. Investors, on the whole, had turned their focus elsewhere...
Read the full article here.
Markets Take Time to be Efficient
Our first contribution to Livewire Markets: Markets are supposed to price in new information efficiently. But for the investor who has done their homework in advance, time is on their side. Stock prices can react gradually rather than instantly to new information. Information can sit in the public domain but not be widely known and understood.
Where was the EPS uplift?
Most of the top-down analysis of the ASX's August reporting season has focused on the surprises and changes in expectations for the S&P/ASX 200. But most of the real action, of course, could be found among stocks that don't have large enough free float market caps to make it in to this key index.
Trying to make sense of the numbers and possibly identify an opportunity or two, we've run the numbers on changes in the consensus expectations among analysts for Earnings Per Share (EPS), using Thomson Reuters data.
Starting where everyone else starts, we count 134 stocks that over the last month experienced upward revisions in EPS expectations for fiscal 2018, compared to 232 downward revisions. The weighted average revision over the last month for the largest 200 stocks (weighted by market capitalisation) was -0.2%.
BUT much of the bad news was pre-warned - the weighted average decline over the past TWO months was -2.4%!
Feel the Cash Burn as Profit Season Closes (or "In memory of Pocketmail")
Another crazy month of reporting financials has come to an end on the ASX, with the typical last minute dump of reports on the evening of August 31 (or the following morning) reflecting unfavourably on business models or financial robustness.
"Have you heard if Company X has approached anyone about a convertible note or something like that", an investor peer asked me in passing on Friday.
No, I hadn't. But I had looked at the financials Company X had just released and I know why he was asking. Cash on hand was equivalent to about 45% of its annual cash burn. Without fresh funding, Company X's brief life could soon come to an end.
Too often founders or cornerstone investors choose to raise just enough funds to get to the next milestone, at which point they are sure investors will significantly revalue the business, allowing a less dilutive round of funding to get to the next milestone.
Get an Edge by Clearing out the Junk
While the newly-launched Equitable Investors Dragonfly Fund will typically be focused on micro to mid caps, its investment universe is not defined directly by company size. Equitable Investors seeks out attractive investment characteristics and market inefficiencies that tend to be more prominent - but not exclusively - among smaller firms.
We've been preparing a paper running through some of the quantitative work researchers have done on the factors and characteristics that help us focus on the listed businesses most worthy of a closer look.
"Quality" is one focal point.
If you're seeking an investment edge, start small
Micro Caps, Factor Spreads, Structural Biases, and the Institutional Imperative, Factor Investor
July 29, 2017
Ehren Stanhope, a principal with quantitative investment firm O'Shaughnessy Asset Management in the US, has crunched some numbers to highlight that "factor investing is more effective in micro than any other cap range". See below his table on the performance of factors across the market cap spectrum. His point - instead of starting with large caps and working backwards in search of excess returns, start in the most bountiful segment of the market and work up: "Investors should start building allocations where competition is low and alpha is less scarce—micro cap. "
A very successful deployment of a "constructive" approach to investment
The Winner’s Picks, Barron's
June 16, 2017
Alantra Asset Management's EQMC Europe Development Capital fund has averaged more than 20% a year, net of fees, since its inception in 2010. On an annualized three-year basis through the end of 2016, it gained more than 26% a year, putting it at the top of Barron’s Penta’s 2017 ranking of Top 100 Hedge Funds. The managers of the fund say most of their returns are driven by good stock-picking, but they also employ what they call “friendly active investing” to nudge core holdings to improve corporate governance, operations, capital allocation, and strategic decisions. Most company chiefs—typically first-time CEOs of public companies—welcome the managers’ guidance. When they don’t, Llanza and de Juan keep their position small, or move on: "We tend to be very constructive. Our strategy is to see how we can create value and help managers. We don’t see ourselves as a hedge fund. We don’t do leverage. We don’t short. This is a long-only strategy. We take a concentrated portfolio of 10 to 15 companies, and in some cases, we take 15% to 20% positions."
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