I’ve just read a really interesting pre-publication paper from Dimitri Vayanos and Paul Woolley called “New Light on Choice of Investment Strategy”. It’s available online. It aims to explain the ability for momentum and value investment strategies to generate returns, while retaining the assumption of rationality. It does this largely by discussing intermediation. It seems a smart addition to the debate in this area, and a useful input to the work I’m doing in support of the Kay Review.
…We find that AIM firms perform poorly on a variety of dimensions. Their post-listing returns significantly underperform stocks on other exchanges. Liquidity is low and there is evidence of substantial information asymmetry. Results are similar across subsets of firms including US firms that directly list on AIM, firms that cross list, and domestic listings. AIM firms do not appear to distinguish themselves through choice of Nomad. Failure rates are very high and there is no evidence that significant numbers develop into “highfliers” or graduate to better exchanges. AIM stocks even underperform stocks that trade on the unregulated “Pink Sheets” in the US, inconsistent with a significant bonding effect of AIM listing.
Room for improvement then, and good reminder to me not to be complacent.
I’ve previously mentioned my support of the petition to end the prohibition on AIM stocks being held in ISAs. The most frequent argument I have had back is that AIM stocks are of poor quality. Clearly there are some poor quality AIM stocks. What of the average quality? This is from the abstract of a working paper Ulf Nielsson of the University of Copenhagen:
…This study, however, shows that these small firms listing on the relatively less regulated AIM market are of similar quality level as firms listing in the U.S. and in continental Europe. Consistent with this result, the failure rate among AIM listed firms is the same as that of other markets. Interestingly, they also raise relatively more capital and have a higher market valuation. Overall, even though high regulation standards may appease investors, the paper questions whether a strict regulation environment will necessarily facilitate stock market prosperity.
This paper does not compare AIM to the Main Market, and I would be interested to see a paper that does. However, I think Nielsson does demolish the crude “AIM stocks are stinkers” line.
I don’t have access to Wiley Online Library, which is a shame, as this paper from 2009 looks very interesting. Abstract:
In spite of the popularity of international portfolio diversification theory, extant empirical literature shows that investors prefer domestic assets and as a result, many studies argue that investors’ portfolios are largely suboptimal. This paper examines whether British investors need to diversify their portfolios internationally to gain performance benefits from international markets or can they obtain these benefits by mimicking the portfolios with domestically traded assets. The results confirm that it is possible to mimic the performance of foreign equity with domestic equity. Indeed, the pay-offs from homemade portfolios outperform those from international portfolios regardless of the periodic variation in the overall performance of the UK market vis-à-vis foreign markets. The superiority of homemade portfolio is more prominent in recent years and is enhanced by the increased internationalisation of developed capital markets. Therefore, investors’ home bias is not suboptimal.
This is good news for UK investors with the smarts to compile their own portfolio, because commissions and tax breaks are much more favourable for UK trades.
On his value investing site, Mark Carter reports some great advice from an investment board post by ‘F958B’. It’s worth repeating:
Investors are not required to have a buy/hold/sell opinion for every share in the market. If in doubt – leave it alone: take no action: do not short it: do not buy it. It can’t go wrong then. Nowadays, we see periodic opportunities to invest in good businesses at sensible prices. There is no need to get involved with falling knives.
Sure, you have a strong, decisive mind. That’s why you’re a value investor. Choosing to leave something alone is a strong decision. If you’re not sure, back away.
At first glance, Hill & Smith Holdings (LON:HILS), a manufacturer of galvanized steel parts, looks quite attractive. Clockwork dividend. P/E ratio under 10. So I looked a little further. It appears that they have about 60% leverage. Just like Plastics Capital (LON:PLA) which I looked at yesterday, their shares are trading at a 50% premium to book, despite having a large amount of intangible assets (~30%) on the balance sheet. The big difference between the two firms is the dividend at Hill, although for me that is counterbalanced by the relatively weak prospects for strong growth in infrastructure and building markets. Hill & Smith doesn’t look like a bad company, but I’m not convinced the share price has anywhere to go – and I can do better than the 4% dividend yield elsewhere. So, again, not for me.