Almost all active investment strategies seek to exploit market inefficiencies and find mispriced securities.
In an excellent paper by Michael Mauboussin available at Bluemountain Investment Research’s website, (link here ) the author speaks of 4 different types of potential market inefficiencies – behavioral inefficiencies, analytical inefficiencies, informational inefficiencies, and technical inefficiencies.
Value investors seek to find and exploit market inefficiencies where securities are mispriced. However, many value investing strategies have had a rough go of it really since the financial crisis. Mispriced securities can be identified and can be purchased but the path to fair pricing has been long and arduous with great volatility for much of the past decade. Why is that?
Perhaps the audience available to correct pricing inefficiencies is thinner than it was in the past. Many retail investors have only reluctantly participated in the equity market in search of income generating securities in light of low available interest rates in more traditional savings vehicles. Other more adventuresome retail investors have been transfixed with the nascent cannabis industry, or for a while with crypto currencies. A form of value investing to which Warren Buffett evolved over his career – the purchase of high quality companies at reasonable prices – has become popular. Is it really a value investing strategy, or has it in fact become a momentum strategy in the guise of value? A popular adherent to this strategy in Canada holds a portfolio of 25 such businesses. Are there really 25 businesses in Canada or even Canada and the U.S. that have impenetrable moats and are available at fair prices? I’m challenged to say yes. However, with some initial success and an increasing pool of capital the buying momentum of such a strategy will succeed – until it doesn’t. That is how momentum strategies work, and ultimately don’t work.
Institutional investors are focused on private equity, and infrastructure projects, and much less on public markets than they used to be.
Who then will correct the pricing inefficiencies? I think the answer will be industry itself. Why build when you can buy. A recent imperfect example of this is a small Takota holding in a company whose shares traded at .25 cents one day, and .65 cents the next after the majority shareholder decided to take the balance of the Company private. That is a control premium bid of +160%. This market price to control bid price discrepancy is small in comparison to some of the other disparities we see in our other portfolio holdings.
While the dynamic of the current environment with fewer mechanisms for value recognition has required a whole new level of patience for a man who is not naturally patient, I still believe that, as Benjamin Graham said, “investing is most successful when it is most businesslike”. No form of investing is more businesslike than the pursuit of areas of market inefficiency and within those areas, the identification and purchase of mispriced securities.