Varecon 01

Ltd

One of the characteristics of modern investors is how compartmentalised or specialised they have become. Institutions typically have a bond team, an equity team, a property team (or, more recently, expanded to include infrastructure in a real assets team, etc. Above them sits an asset allocation team or process, with re-weighting of capital allocations depending on the pricing of risk and return expectations in the short-term. Even private investors tend to allocate their capital in a similar fashion. Such structures help develop a formalised investment process, but they also contribute to missing some investment opportunities. Take, for instance, the example of a listed fund that invests in corporate debt. The performance of such a fund will be rather different to that of the general equities market. Rising GDP will be a positive indicator for companies’ profits, but only be of marginal benefit (in terms of improving the debt security) for the performance of debt fund. Such a fund will perform, in fundamental terms, much more like short-dated bonds than an equity. Consequently, equity investors will tend to shun it; it does not meet their criteria. Then you have high yielding (‘junk’) and distressed corporate bonds. These behave much more like equities, with the risk premium and default risk adjusting to the performance of the borrower or of the sector in which the borrower is operating. Bond investors will, similarly, tend to shun these, whatever their performance prospects may be. Indeed, many institutional bond investors are prohibited from investing outside ‘investment grade’. In turn, property investors almost exclusively buy the real assets, even though it is clear that asset-backed debt secured on similar properties is going to provide a better return. These are instances of what I believe are market inefficiencies arising from structural inefficiencies. Most importantly, the consequence is mispricing. Fishing in these unconventional pools can provide exceptional returns, as well as achieving diversification.

Fishing in these unconventional pools can provide exceptional returns, as well as achieving diversification