The importance of these sources is simple: the majority of alternative investments are very illiquid and can only be held safely in closed-ended trusts. Open-ended funds are all too prone to suffer demands for redemption at precisely the moment when underlying investments cannot be sold.
But there is something more to investment than the metrics, or analysis of a security against its past history: the market as a whole, and its current price and dividend yield. This is the reality of the business itself – asking what competition does it face, what are the technological risks to its products and market positioning, and what changes in the social and demographic nature of its business have occurred. As Warren Buffett remarked many decades ago on his first business: “When a leader renowned for his skill comes across a business with bad economics, the business always wins.”
So investment is always more than metrics. It is also more than growth, for as Terry Smith of Fundsmith recently reported in the Financial Times, equities do not always do better than bonds; indeed the opposite!
Does CAPM work?
Hendrik Bessembinder, of Arizona State University, has recently compiled a study of S&P 500, Nasdaq and Dow Jones constituents over the past 90 years and, surprisingly, discovered that on average Treasury bills did better than equities. The main reason is that those companies that do well for investors are few and far between, and most businesses do not do well enough in terms of capital growth to make up for the compounding of the regular income from the T-bill.
Maybe the principle of the capital asset pricing model does work, but only if investors can identify the very few companies that outperform. This, then, is the appeal of hedge fund managers.
Finding good hedge fund managers is neither simple nor cheap, but there are plenty of good closed-ended fund managers with a regular history of producing T-bill like returns. The best of these do not look solely at the metrics of their would-be investments, but also the basics of the actual business. Nor do they neglect the most attractive element of an equity. As Mr Buffett has demonstrated with Berkshire Hathaway, the best way of compounding growth is not paying out dividends, but reinvesting them within the business; taxes are avoided and the full amount of cash profits are efficiently reinvested.
The least efficient is that which most investors do. Identifying high-yielding shares, taking dividends and paying taxes, then reinvesting in another company, paying yet more expenses, and hoping that the new investment is better than the old.
Companies that pay higher dividends than the market are suspicious, while those that pay less are not necessarily safer – just short of cash, and how can that be if they are profitable?
